Third Age Health Services Limited's (NZSE:TAH) Stock On An Uptrend: Could Fundamentals Be Driving The Momentum?

editorial-team@simplywallst.com (Simply Wall St)

Thu, Apr 25, 2024, 2:33 PM 4 min read

Third Age Health Services (NZSE:TAH) has had a great run on the share market with its stock up by a significant 27% over the last three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to Third Age Health Services' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Third Age Health Services

How To Calculate Return On Equity?

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 Third Age Health Services is:

23% = NZ$625k ÷ NZ$2.7m (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 NZ$1 of shareholders' capital it has, the company made NZ$0.23 in profit.

Why Is ROE Important For 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. 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.

Third Age Health Services' Earnings Growth And 23% ROE

Firstly, we acknowledge that Third Age Health Services has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 5.7% also doesn't go unnoticed by us. As you might expect, the 12% net income decline reported by Third Age Health Services doesn't bode well with us. So, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.

However, when we compared Third Age Health Services' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 14% in the same period. This is quite worrisome.

past-earnings-growth — NZSE:TAH Past Earnings Growth April 25th 2024

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. 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 Third Age Health Services is trading on a high P/E or a low P/E, relative to its industry.

Is Third Age Health Services Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 76% (implying that 24% of the profits are retained), most of Third Age Health Services' profits are being paid to shareholders, which explains the company's shrinking earnings. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. You can see the 5 risks we have identified for Third Age Health Services by visiting our risks dashboard for free on our platform here.

Additionally, Third Age Health Services has paid dividends over a period of three years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Summary

In total, it does look like Third Age Health Services has some positive aspects to its business. However, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. So far, we've only made a quick discussion around the company's earnings growth. To gain further insights into Third Age Health Services' past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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.