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With its stock down 13% over the past three months, it is easy to disregard Meritage Homes (NYSE:MTH). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Meritage Homes' ROE in this article.
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.
View our latest analysis for Meritage Homes
How Do You 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 Meritage Homes is:
17% = US$375m ÷ US$2.2b (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 $0.17 in profit.
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. 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.
Meritage Homes' Earnings Growth And 17% ROE
At first glance, Meritage Homes seems to have a decent ROE. Even when compared to the industry average of 16% the company's ROE looks quite decent. Consequently, this likely laid the ground for the impressive net income growth of 20% seen over the past five years by Meritage Homes. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
We then performed a comparison between Meritage Homes' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 19% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. If you're wondering about Meritage Homes''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.