National HealthCare's (NYSEMKT:NHC) stock is up by 6.9% over the past three months. However, its weak financial performance indicators makes us a bit doubtful if that trend could continue. Particularly, we will be paying attention to National HealthCare's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for National HealthCare is:
3.6% = US$28m ÷ US$777m (Based on the trailing twelve months to September 2020).
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 $0.04 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. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
National HealthCare's Earnings Growth And 3.6% ROE
As you can see, National HealthCare's ROE looks pretty weak. Even when compared to the industry average of 13%, the ROE figure is pretty disappointing. Hence, the flat earnings seen by National HealthCare over the past five years could probably be the result of it having a lower ROE.
Next, on comparing with the industry net income growth, we found that National HealthCare's reported growth was lower than the industry growth of 8.0% in the same period, which is not something we like to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about National HealthCare's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is National HealthCare Using Its Retained Earnings Effectively?
National HealthCare has a high three-year median payout ratio of 51% (or a retention ratio of 49%), meaning that the company is paying most of its profits as dividends to its shareholders. This does go some way in explaining why there's been no growth in its earnings.
In addition, National HealthCare has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.
In total, we would have a hard think before deciding on any investment action concerning National HealthCare. As a result of its low ROE and lack of mich reinvestment into the business, the company has seen a disappointing earnings growth rate. So far, we've only made a quick discussion around the company's earnings growth. To gain further insights into National HealthCare's past profit growth, check out this visualization of past earnings, revenue and cash flows.
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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