Is Capitol Health Limited's (ASX:CAJ) Latest Stock Performance A Reflection Of Its Financial Health?

Capitol Health's's (ASX:CAJ) stock is up by a considerable 55% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Capitol Health's 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Capitol Health

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Capitol Health is:

16% = AU$18m ÷ AU$115m (Based on the trailing twelve months to December 2019).

The 'return' is the profit over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.16 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learnt that ROE measures how efficiently a company is generating its profits. 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 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.

Capitol Health's Earnings Growth And 16% ROE

At first glance, Capitol Health seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 11%. This probably laid the ground for Capitol Health's significant 30% net income growth seen over the past five years. We reckon that there could also be other factors at play here. Such as - high earnings retention or an efficient management in place.

We then compared Capitol Health's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 4.6% in the same period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Capitol Health is trading on a high P/E or a low P/E, relative to its industry.

Is Capitol Health Making Efficient Use Of Its Profits?

Capitol Health's three-year median payout ratio is a pretty moderate 31%, meaning the company retains 69% of its income. By the looks of it, the dividend is well covered and Capitol Health is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Besides, Capitol Health has been paying dividends over a period of eight years. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 46% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company's expected ROE (to 7.7%) over the same period.

Conclusion

In total, we are pretty happy with Capitol Health's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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This article by Simply Wall St is general in nature. 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.
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