Netcare's (JSE:NTC) stock up by 5.8% over the past three months. However, in this article, we decided to focus on its weak financials, as long-term fundamentals ultimately dictate market outcomes. Specifically, we decided to study Netcare's ROE in this article.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
View our latest analysis for Netcare
How Is ROE Calculated?
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 Netcare is:
12% = R1.3b ÷ R11b (Based on the trailing twelve months to September 2023).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each ZAR1 of shareholders' capital it has, the company made ZAR0.12 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
Netcare's Earnings Growth And 12% ROE
On the face of it, Netcare's ROE is not much to talk about. However, given that the company's ROE is similar to the average industry ROE of 14%, we may spare it some thought. But then again, Netcare's five year net income shrunk at a rate of 17%. Remember, the company's ROE is a bit low to begin with. Hence, this goes some way in explaining the shrinking earnings.
So, as a next step, we compared Netcare's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 0.4% over the last few years.
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 NTC fairly valued? This infographic on the company's intrinsic value has everything you need to know.