Should Weakness in McGrath RentCorp's (NASDAQ:MGRC) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?
McGrath RentCorp (NASDAQ:MGRC) has had a rough three months with its share price down 15%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to McGrath RentCorp's ROE today.
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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
See our latest analysis for McGrath RentCorp
How To Calculate Return On Equity?
ROE 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 McGrath RentCorp is:
13% = US$109m ÷ US$860m (Based on the trailing twelve months to March 2023).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.13.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
McGrath RentCorp's Earnings Growth And 13% ROE
To start with, McGrath RentCorp's ROE looks acceptable. Even so, when compared with the average industry ROE of 19%, we aren't very excited. Further research shows that McGrath RentCorp's net income has shrunk at a rate of 6.7% over the last five years. Bear in mind, the company does have a high ROE. It is just that the industry ROE is higher. So there might be other reasons for the earnings to shrink. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.
However, when we compared McGrath RentCorp's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 20% in the same period. This is quite worrisome.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is McGrath RentCorp fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is McGrath RentCorp Efficiently Re-investing Its Profits?
In spite of a normal three-year median payout ratio of 41% (that is, a retention ratio of 59%), the fact that McGrath RentCorp's earnings have shrunk is quite puzzling. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
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.
Conclusion
On the whole, we do feel that McGrath RentCorp has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a moderate ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
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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.
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