Most readers would already be aware that Royalty Pharma's (NASDAQ:RPRX) stock increased significantly by 6.7% over the past month. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to Royalty Pharma's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Royalty Pharma

How Is ROE Calculated?

ROE can be calculated by using the formula:

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

So, based on the above formula, the ROE for Royalty Pharma is:

11% = US$1.0b ÷ US$9.8b (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.11 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Royalty Pharma's Earnings Growth And 11% ROE

To begin with, Royalty Pharma seems to have a respectable ROE. Yet, the fact that the company's ROE is lower than the industry average of 21% does temper our expectations. Needless to say, the 37% net income shrink rate seen by Royalty Pharmaover the past five years is a huge dampener. Bear in mind, the company does have a high ROE. It is just that the industry ROE is higher. So there might be other reasons for the earnings to shrink. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

As a next step, we compared Royalty Pharma's performance with the industry and found thatRoyalty Pharma's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 0.3% in the same period, which is a slower than the company.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for RPRX? You can find out in our latest intrinsic value infographic research report.