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Should Weakness in American Homes 4 Rent's (NYSE:AMH) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

Simply Wall St

It is hard to get excited after looking at American Homes 4 Rent's (NYSE:AMH) recent performance, when its stock has declined 12% over the past three months. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study American Homes 4 Rent's ROE in this article.

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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for American Homes 4 Rent

How Do You Calculate Return On Equity?

Return on equity can be calculated by using the formula:

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

So, based on the above formula, the ROE for American Homes 4 Rent is:

2.6% = US$156m ÷ US$6.0b (Based on the trailing twelve months to December 2019).

The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.03 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learnt 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.

American Homes 4 Rent's Earnings Growth And 2.6% ROE

It is quite clear that American Homes 4 Rent's ROE is rather low. Not just that, even compared to the industry average of 5.8%, the company's ROE is entirely unremarkable. However, we we're pleasantly surprised to see that American Homes 4 Rent grew its net income at a significant rate of 64% in the last five years. Therefore, there could be other reasons behind this growth. Such as - high earnings retention or an efficient management in place.

We then compared American Homes 4 Rent's 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 15% in the same period.

NYSE:AMH Past Earnings Growth April 17th 2020

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. Doing so will help them establish if the stock's future looks promising or ominous. What is AMH worth today? The intrinsic value infographic in our free research report helps visualize whether AMH is currently mispriced by the market.

Is American Homes 4 Rent Making Efficient Use Of Its Profits?

The three-year median payout ratio for American Homes 4 Rent is 35%, which is moderately low. The company is retaining the remaining 65%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like American Homes 4 Rent is reinvesting its earnings efficiently.

Besides, American Homes 4 Rent has been paying dividends over a period of six years. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 0.05% over the next three years. Regardless, the future ROE for American Homes 4 Rent is predicted to decline to 0.9% despite the anticipated decrease in the payout ratio. We reckon that there could probably be other factors that could be driving the forseen decline in the company's ROE.

Summary

On the whole, we do feel that American Homes 4 Rent has some positive attributes. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. 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.

If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.

We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.