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Most readers would already be aware that Healthcare Services Group's (NASDAQ:HCSG) stock increased significantly by 8.8% over the past month. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on Healthcare Services Group's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.
View our latest analysis for Healthcare Services Group
How Is ROE Calculated?
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 Healthcare Services Group is:
10% = US$51m ÷ US$489m (Based on the trailing twelve months to September 2024).
The 'return' is the profit over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.10.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.
A Side By Side comparison of Healthcare Services Group's Earnings Growth And 10% ROE
At first glance, Healthcare Services Group's ROE doesn't look very promising. However, its ROE is similar to the industry average of 12%, so we won't completely dismiss the company. Having said that, Healthcare Services Group's five year net income decline rate was 22%. Remember, the company's ROE is a bit low to begin with. Hence, this goes some way in explaining the shrinking earnings.
However, when we compared Healthcare Services Group's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 11% 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. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Healthcare Services Group fairly valued compared to other companies? These 3 valuation measures might help you decide.