Is Medibank Private Limited's (ASX:MPL) Recent Stock Performance Influenced By Its Financials In Any Way?

Medibank Private's (ASX:MPL) stock is up by 7.3% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to investigate if the company's decent financials had a hand to play in the recent price move. Specifically, we decided to study Medibank Private'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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Medibank Private

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 Medibank Private is:

17% = AU$316m ÷ AU$1.8b (Based on the trailing twelve months to June 2020).

The 'return' is the income the business earned over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.17.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned 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.

Medibank Private's Earnings Growth And 17% ROE

To begin with, Medibank Private seems to have a respectable ROE. Especially when compared to the industry average of 9.5% the company's ROE looks pretty impressive. However, we are curious as to how the high returns still resulted in flat growth for Medibank Private in the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. These include low earnings retention or poor allocation of capital.

Next, on comparing with the industry net income growth, we found that Medibank Private's reported growth was lower than the industry growth of 4.2% in the same period, which is not something we like to see.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for MPL? You can find out in our latest intrinsic value infographic research report.

Is Medibank Private Making Efficient Use Of Its Profits?

Medibank Private has a high three-year median payout ratio of 83% (or a retention ratio of 17%), meaning that the company is paying most of its profits as dividends to its shareholders. This does go some way in explaining why there's been no growth in its earnings.

Moreover, Medibank Private has been paying dividends for five years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 85%. As a result, Medibank Private's ROE is not expected to change by much either, which we inferred from the analyst estimate of 20% for future ROE.

Conclusion

Overall, we feel that Medibank Private certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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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