Can Welltower Inc.'s (NYSE:WELL) Weak Financials Pull The Plug On The Stock's Current Momentum On Its Share Price?
Most readers would already be aware that Welltower's (NYSE:WELL) stock increased significantly by 12% over the past three months. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimatley dictates market outcomes. Particularly, we will be paying attention to Welltower'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. Put another way, it reveals the company's success at turning shareholder investments into profits.
View our latest analysis for Welltower
How To 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 Welltower is:
2.0% = US$374m ÷ US$19b (Based on the trailing twelve months to December 2021).
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 $0.02 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
A Side By Side comparison of Welltower's Earnings Growth And 2.0% ROE
It is hard to argue that Welltower's ROE is much good in and of itself. Not just that, even compared to the industry average of 6.5%, the company's ROE is entirely unremarkable. Given the circumstances, the significant decline in net income by 4.5% seen by Welltower over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.
That being said, we compared Welltower's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 11% in the same period.
Earnings growth is a huge factor in stock valuation. 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. Has the market priced in the future outlook for WELL? You can find out in our latest intrinsic value infographic research report.
Is Welltower Using Its Retained Earnings Effectively?
Welltower has a very high three-year median payout ratio of 94%, implying that it retains only 5.8% of its profits. However, it's not unusual to see a REIT with such a high payout ratio mainly due to statutory requirements. So this probably explains the company's shrinking earnings.
In addition, Welltower 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. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 62% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 4.4%, over the same period.
Conclusion
Overall, we would be extremely cautious before making any decision on Welltower. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.
