Yahoo Finance Does Ramsay Health Care Limited's (ASX:RHC) Weak Fundamentals Mean A Downturn In Its Stock Should Be Expected?
Ramsay Health Care's (ASX:RHC) stock up by 4.0% over the past month. However, in this article, we decided to focus on its weak financials, as long-term fundamentals ultimately dictate market outcomes. Particularly, we will be paying attention to Ramsay Health Care's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. 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 Ramsay Health Care
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 Ramsay Health Care is:
7.0% = AU$311m ÷ AU$4.4b (Based on the trailing twelve months to December 2020).
The 'return' is the profit over the last twelve months. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.07.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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.
Ramsay Health Care's Earnings Growth And 7.0% ROE
When you first look at it, Ramsay Health Care's ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 12% either. Therefore, it might not be wrong to say that the five year net income decline of 5.2% seen by Ramsay Health Care was probably the result of it having a lower ROE. We reckon that there could also be other factors at play here. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.
However, when we compared Ramsay Health Care's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 4.2% in the same period. This is quite worrisome.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is RHC fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Ramsay Health Care Using Its Retained Earnings Effectively?
Ramsay Health Care's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 60% (or a retention ratio of 40%). With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 3 risks we have identified for Ramsay Health Care by visiting our risks dashboard for free on our platform here.
In addition, Ramsay Health Care 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 56%. However, Ramsay Health Care's ROE is predicted to rise to 15% despite there being no anticipated change in its payout ratio.
Summary
In total, we would have a hard think before deciding on any investment action concerning Ramsay Health Care. 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. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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