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Do Fundamentals Have Any Role To Play In Driving Johnson & Johnson's (NYSE:JNJ) Stock Up Recently?

Johnson & Johnson's (NYSE:JNJ) stock up by 7.0% over the past three months. As most would know, long-term fundamentals have a strong correlation with market price movements, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study Johnson & Johnson's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Johnson & Johnson

How To Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Johnson & Johnson is:

19% = US$13b ÷ US$69b (Based on the trailing twelve months to December 2023).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.19.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 Johnson & Johnson's Earnings Growth And 19% ROE

To begin with, Johnson & Johnson seems to have a respectable ROE. Even when compared to the industry average of 17% the company's ROE looks quite decent. However, we are curious as to how Johnson & Johnson's decent returns still resulted in flat growth for Johnson & Johnson in the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

We then compared Johnson & Johnson's net income growth with the industry and found that the average industry growth rate was 6.5% in the same 5-year period.

past-earnings-growth
past-earnings-growth

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. Has the market priced in the future outlook for JNJ? You can find out in our latest intrinsic value infographic research report.

Is Johnson & Johnson Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 70% (meaning, the company retains only 30% of profits) for Johnson & Johnson suggests that the company's earnings growth was miniscule as a result of paying out a majority of its earnings.

Moreover, Johnson & Johnson has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 47% over the next three years. The fact that the company's ROE is expected to rise to 31% over the same period is explained by the drop in the payout ratio.

Conclusion

On the whole, we do feel that Johnson & Johnson has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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

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.