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Oceania Healthcare (NZSE:OCA) has had a great run on the share market with its stock up by a significant 24% over the last three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to Oceania Healthcare's ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
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 Oceania Healthcare is:
9.5% = NZ$59m ÷ NZ$618m (Based on the trailing twelve months to November 2019).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every NZ$1 worth of equity, the company was able to earn NZ$0.10 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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. 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.
Oceania Healthcare's Earnings Growth And 9.5% ROE
On the face of it, Oceania Healthcare's ROE is not much to talk about. However, given that the company's ROE is similar to the average industry ROE of 9.5%, we may spare it some thought. On the other hand, Oceania Healthcare reported a moderate 8.2% net income growth over the past five years. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. For instance, the company has a low payout ratio or is being managed efficiently.
We then performed a comparison between Oceania Healthcare's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 8.2% in the same 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. This then helps them determine if the stock is placed for a bright or bleak future. 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 Oceania Healthcare is trading on a high P/E or a low P/E, relative to its industry.
Is Oceania Healthcare Efficiently Re-investing Its Profits?
The high three-year median payout ratio of 50% (or a retention ratio of 50%) for Oceania Healthcare suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.
While Oceania Healthcare has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 56%. Still, forecasts suggest that Oceania Healthcare's future ROE will drop to 7.1% even though the the company's payout ratio is not expected to change by much.
In total, it does look like Oceania Healthcare has some positive aspects to its business. That is, quite an impressive growth in earnings. However, the low profit retention means that the company's earnings growth could have been higher, had it been reinvesting a higher portion of its profits. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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