Ramsay Health Care Limited (ASX:RHC) Stock's On A Decline: Are Poor Fundamentals The Cause?

With its stock down 4.7% over the past three months, 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. In this article, we decided to focus on Ramsay Health Care's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Ramsay Health Care

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 Ramsay Health Care is:

4.8% = AU$263m ÷ AU$5.5b (Based on the trailing twelve months to June 2024).

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$0.05 in profit.

What Is The Relationship Between ROE And Earnings Growth?

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

When you first look at it, Ramsay Health Care's ROE doesn't look that attractive. Next, when compared to the average industry ROE of 6.7%, the company's ROE leaves us feeling even less enthusiastic. For this reason, Ramsay Health Care's five year net income decline of 14% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. Such as - low earnings retention or poor allocation of capital.

As a next step, we compared Ramsay Health Care's performance with the industry and found thatRamsay Health Care's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 3.3% in the same period, which is a slower than the company.

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 Ramsay Health Care is trading on a high P/E or a low P/E, relative to its industry.

Is Ramsay Health Care Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 79% (implying that 21% of the profits are retained), most of Ramsay Health Care's profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent.

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. Existing analyst estimates suggest 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.

Conclusion

Overall, we would be extremely cautious before making any decision on Ramsay Health Care. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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. 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.