Is Ramsay Health Care Limited's (ASX:RHC) Stock On A Downtrend As A Result Of Its Poor Financials?

With its stock down 8.0% over the past month, it is easy to disregard Ramsay Health Care (ASX:RHC). Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. Specifically, we decided to study Ramsay Health Care's ROE in this article.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Ramsay Health Care

How Is ROE Calculated?

The formula for return on equity is:

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

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

4.7% = AU$257m ÷ AU$5.5b (Based on the trailing twelve months to December 2023).

The 'return' is the profit over the last twelve months. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.05.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Ramsay Health Care's Earnings Growth And 4.7% ROE

On the face of it, Ramsay Health Care's ROE is not much to talk about. However, its ROE is similar to the industry average of 4.7%, so we won't completely dismiss the company. Having said that, Ramsay Health Care's five year net income decline rate was 13%. Bear in mind, the company does have a slightly low ROE. So that's what might be causing earnings growth to shrink.

That being said, we compared Ramsay Health Care's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 1.5% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. 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. Has the market priced in the future outlook for RHC? You can find out in our latest intrinsic value infographic research report.

Is Ramsay Health Care Using Its Retained Earnings Effectively?

Ramsay Health Care has a high three-year median payout ratio of 78% (that is, it is retaining 22% 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 a little being reinvested into the business, earnings growth would obviously be low or non-existent. To know the 2 risks we have identified for Ramsay Health Care visit our risks dashboard for free.

In addition, Ramsay Health Care has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 60% 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 12%, over the same period.

Conclusion

On the whole, Ramsay Health Care's performance is quite a big let-down. 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. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.