With its stock down 5.8% over the past three months, it is easy to disregard Zimmer Biomet Holdings (NYSE:ZBH). However, stock prices are usually driven by a company's financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Zimmer Biomet Holdings' ROE today.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

How Is ROE Calculated?

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 Zimmer Biomet Holdings is:

8.8% = US$1.1b ÷ US$12b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.09 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

A Side By Side comparison of Zimmer Biomet Holdings' Earnings Growth And 8.8% ROE

At first glance, Zimmer Biomet Holdings' ROE doesn't look very promising. Next, when compared to the average industry ROE of 12%, the company's ROE leaves us feeling even less enthusiastic. However, we we're pleasantly surprised to see that Zimmer Biomet Holdings grew its net income at a significant rate of 24% in the last five years. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place.

We then compared Zimmer Biomet Holdings' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 12% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Zimmer Biomet Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Zimmer Biomet Holdings Making Efficient Use Of Its Profits?

Zimmer Biomet Holdings' three-year median payout ratio is a pretty moderate 42%, meaning the company retains 58% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Zimmer Biomet Holdings is reinvesting its earnings efficiently.

Additionally, Zimmer Biomet Holdings 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 10% over the next three years. As a result, the expected drop in Zimmer Biomet Holdings' payout ratio explains the anticipated rise in the company's future ROE to 15%, over the same period.

Conclusion

Overall, we feel that Zimmer Biomet Holdings certainly does have some positive factors to consider. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. 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.