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ResMed Inc.'s (NYSE:RMD) Stock Is Going Strong: Have Financials A Role To Play?

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Simply Wall St
·4 min read
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Most readers would already be aware that ResMed's (NYSE:RMD) stock increased significantly by 16% 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. In this article, we decided to focus on ResMed's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for ResMed

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for ResMed is:

25% = US$680m ÷ US$2.7b (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.25 in profit.

Why Is ROE Important For 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. 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.

A Side By Side comparison of ResMed's Earnings Growth And 25% ROE

First thing first, we like that ResMed has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 12% also doesn't go unnoticed by us. This likely paved the way for the modest 12% net income growth seen by ResMed over the past five years. growth

Next, on comparing with the industry net income growth, we found that ResMed's reported growth was lower than the industry growth of 16% in the same period, which is not something we like to see.

past-earnings-growth
past-earnings-growth

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is ResMed fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is ResMed Making Efficient Use Of Its Profits?

While ResMed has a three-year median payout ratio of 52% (which means it retains 48% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.

Moreover, ResMed is determined to keep sharing its profits with shareholders which we infer from its long history of eight years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 32% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.

Summary

On the whole, we do feel that ResMed has some positive attributes. Its earnings have grown respectably as we saw earlier, which was likely due to the company reinvesting its earnings at a pretty high rate of return. However, given the high ROE, we do think that the company is reinvesting a small portion of its profits. This could likely be preventing the company from growing to its full extent. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. 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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