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M/I Homes (NYSE:MHO) has had a rough month with its share price down 13%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on M/I Homes' 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.
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 M/I Homes is:
22% = US$293m ÷ US$1.4b (Based on the trailing twelve months to March 2021).
The 'return' refers to a company's earnings over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.22.
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. 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 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.
M/I Homes' Earnings Growth And 22% ROE
To start with, M/I Homes' ROE looks acceptable. Further, the company's ROE is similar to the industry average of 18%. Consequently, this likely laid the ground for the impressive net income growth of 36% seen over the past five years by M/I Homes. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.
We then compared M/I Homes' 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 17% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if M/I Homes is trading on a high P/E or a low P/E, relative to its industry.
Is M/I Homes Using Its Retained Earnings Effectively?
Given that M/I Homes doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.
Overall, we are quite pleased with M/I Homes' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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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