Exelixis, Inc.'s (NASDAQ:EXEL) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

With its stock down 24% over the past three months, it is easy to disregard Exelixis (NASDAQ:EXEL). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Exelixis' ROE.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Exelixis

How To Calculate Return On Equity?

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 Exelixis is:

11% = US$273m ÷ US$2.4b (Based on the trailing twelve months to June 2022).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $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 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 Exelixis' Earnings Growth And 11% ROE

To start with, Exelixis' ROE looks acceptable. Yet, the fact that the company's ROE is lower than the industry average of 23% does temper our expectations. Needless to say, the 7.5% net income shrink rate seen by Exelixisover the past five years is a huge dampener. Not to forget, the company does have a high ROE to begin with, just that it is lower than the industry average. So there might be other reasons for the earnings to shrink. These include low earnings retention or poor allocation of capital.

That being said, we compared Exelixis' performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 21% in the same period.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Exelixis''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Exelixis Efficiently Re-investing Its Profits?

Because Exelixis doesn't pay any dividends, we infer that it is retaining all of its profits, which is rather perplexing when you consider the fact that there is no earnings growth to show for it. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Summary

In total, it does look like Exelixis has some positive aspects to its business. However, while the company does have a decent ROE and a high profit retention, its earnings growth number is quite disappointing. This suggests that there might be some external threat to the business, that's hampering growth. 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.

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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.

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