With its stock down 2.0% over the past three months, it is easy to disregard RMR Group (NASDAQ:RMR). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on RMR Group's ROE.
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. Put another way, it reveals the company's success at turning shareholder investments into profits.
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 RMR Group is:
11% = US$61m ÷ US$546m (Based on the trailing twelve months to March 2021).
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 Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
RMR Group's Earnings Growth And 11% ROE
At first glance, RMR Group seems to have a decent ROE. Especially when compared to the industry average of 8.3% the company's ROE looks pretty impressive. For this reason, RMR Group's five year net income decline of 3.8% raises the question as to why the high ROE didn't translate into earnings growth. Therefore, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.
That being said, we compared RMR Group's 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 13% in the same period.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is RMR Group fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is RMR Group Using Its Retained Earnings Effectively?
Looking at its three-year median payout ratio of 31% (or a retention ratio of 69%) which is pretty normal, RMR Group's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
Moreover, RMR Group has been paying dividends for five years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 81% over the next three years. Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.
In total, it does look like RMR Group has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. 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.
This article by Simply Wall St is general in nature. 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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