It is hard to get excited after looking at Ramsay Health Care's (ASX:RHC) recent performance, when its stock has declined 2.0% over the past three months. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. Particularly, we will be paying attention to Ramsay Health Care'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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Ramsay Health Care is:
4.8% = AU$263m ÷ AU$5.5b (Based on the trailing twelve months to June 2024).
The 'return' is the income the business earned over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.05.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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 Ramsay Health Care's Earnings Growth And 4.8% ROE
At first glance, Ramsay Health Care's ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 6.7%. Therefore, it might not be wrong to say that the five year net income decline of 14% seen by Ramsay Health Care was probably the result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.
Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate of 3.3% over the last few years, we found that Ramsay Health Care's performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.
ASX:RHC Past Earnings Growth December 2nd 2024
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). Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Ramsay Health Care is trading on a high P/E or a low P/E, relative to its industry.
Is Ramsay Health Care Efficiently Re-investing Its Profits?
Ramsay Health Care has a high three-year median payout ratio of 79% (that is, it is retaining 21% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only very little left to reinvest into the business, growth in earnings is far from likely.
Additionally, Ramsay Health Care has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 63% over the next three years. As a result, the expected drop in Ramsay Health Care's payout ratio explains the anticipated rise in the company's future ROE to 9.2%, over the same period.
Summary
Overall, we would be extremely cautious before making any decision on 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. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.
Have feedback on this article? Concerned about the content?Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
