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McGrath RentCorp's (NASDAQ:MGRC) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

·4 min read

McGrath RentCorp's (NASDAQ:MGRC) stock is up by a considerable 11% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study McGrath RentCorp's ROE in this article.

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

View our latest analysis for McGrath RentCorp

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 McGrath RentCorp is:

12% = US$90m ÷ US$732m (Based on the trailing twelve months to December 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 $0.12 in profit.

Why Is ROE Important For 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 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.

McGrath RentCorp's Earnings Growth And 12% ROE

At first glance, McGrath RentCorp seems to have a decent ROE. Yet, the fact that the company's ROE is lower than the industry average of 23% does temper our expectations. Further, McGrath RentCorp's five year net income growth of 4.0% is on the lower side. Bear in mind, the company does have a respectable level of ROE. It is just that the industry ROE is higher. So there might be other reasons for the earnings growth to be low. These include low earnings retention or poor capital allocation.

Next, on comparing with the industry net income growth, we found that McGrath RentCorp's reported growth was lower than the industry growth of 12% in the same period, which is not something we like to see.

past-earnings-growth
past-earnings-growth

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. What is MGRC worth today? The intrinsic value infographic in our free research report helps visualize whether MGRC is currently mispriced by the market.

Is McGrath RentCorp Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 40% (or a retention ratio of 60% over the past three years, McGrath RentCorp has seen very little growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Moreover, McGrath RentCorp has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 36% of its profits over the next three years. Regardless, the future ROE for McGrath RentCorp is predicted to rise to 16% despite there being not much change expected in its payout ratio.

Summary

On the whole, we do feel that McGrath RentCorp has some positive attributes. 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. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.