Declining Stock and Solid Fundamentals: Is The Market Wrong About Cochlear Limited (ASX:COH)?
It is hard to get excited after looking at Cochlear's (ASX:COH) recent performance, when its stock has declined 8.2% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Cochlear's ROE today.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How To Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Cochlear is:
20% = AU$389m ÷ AU$2.0b (Based on the trailing twelve months to June 2025).
The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.20 in profit.
Check out our latest analysis for Cochlear
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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Cochlear's Earnings Growth And 20% ROE
To start with, Cochlear's ROE looks acceptable. Especially when compared to the industry average of 12% the company's ROE looks pretty impressive. Probably as a result of this, Cochlear was able to see an impressive net income growth of 33% over the last five years. However, there could also be other causes behind this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
Next, on comparing with the industry net income growth, we found that Cochlear's growth is quite high when compared to the industry average growth of 20% in the same period, which is great to see.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Cochlear's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Cochlear Efficiently Re-investing Its Profits?
Cochlear has a significant three-year median payout ratio of 73%, meaning the company only retains 27% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.
Additionally, Cochlear 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 70%. Regardless, the future ROE for Cochlear is predicted to rise to 26% despite there being not much change expected in its payout ratio.
Conclusion
Overall, we are quite pleased with Cochlear's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.
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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.