Thermo Fisher Scientific (NYSE:TMO) has had a rough month with its share price down 4.6%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Thermo Fisher Scientific's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. Put another way, it reveals the company's success at turning shareholder investments into profits.

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Thermo Fisher Scientific is:

13% = US$6.0b ÷ US$46b (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.13 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company's earnings growth potential. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Thermo Fisher Scientific's Earnings Growth And 13% ROE

At first glance, Thermo Fisher Scientific seems to have a decent ROE. Even when compared to the industry average of 12% the company's ROE looks quite decent. Consequently, this likely laid the ground for the decent growth of 11% seen over the past five years by Thermo Fisher Scientific.

Next, on comparing with the industry net income growth, we found that Thermo Fisher Scientific's reported growth was lower than the industry growth of 17% over the last few years, which is not something we like to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Thermo Fisher Scientific is trading on a high P/E or a low P/E, relative to its industry.

Is Thermo Fisher Scientific Efficiently Re-investing Its Profits?

In Thermo Fisher Scientific's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 6.5% (or a retention ratio of 94%), which suggests that the company is investing most of its profits to grow its business.

Additionally, Thermo Fisher Scientific has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 6.5%. Still, forecasts suggest that Thermo Fisher Scientific's future ROE will rise to 18% even though the the company's payout ratio is not expected to change by much.

Summary

In total, we are pretty happy with Thermo Fisher Scientific's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com