Will Weakness in Austco Healthcare Limited's (ASX:AHC) Stock Prove Temporary Given Strong Fundamentals?

With its stock down 14% over the past week, it is easy to disregard Austco Healthcare (ASX:AHC). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Austco Healthcare'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Austco Healthcare

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 Austco Healthcare is:

15% = AU$2.5m ÷ AU$16m (Based on the trailing twelve months to June 2020).

The 'return' is the yearly profit. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.15 in profit.

What Is The Relationship Between ROE And 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 Austco Healthcare's Earnings Growth And 15% ROE

To start with, Austco Healthcare's ROE looks acceptable. Even when compared to the industry average of 14% the company's ROE looks quite decent. Consequently, this likely laid the ground for the impressive net income growth of 43% seen over the past five years by Austco Healthcare. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Austco Healthcare's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 17%.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is Austco Healthcare fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Austco Healthcare Using Its Retained Earnings Effectively?

Conclusion

Overall, we are quite pleased with Austco Healthcare's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. You can see the 2 risks we have identified for Austco Healthcare by visiting our risks dashboard for free on our platform here.

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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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