Rural Funds Group's (ASX:RFF) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

Rural Funds Group (ASX:RFF) has had a rough month with its share price down 5.0%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Rural Funds Group's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Rural Funds Group

How Is ROE Calculated?

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 Rural Funds Group is:

8.5% = AU$48m ÷ AU$558m (Based on the trailing twelve months to June 2020).

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$0.09 in profit.

What Has ROE Got To Do With 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Rural Funds Group's Earnings Growth And 8.5% ROE

When you first look at it, Rural Funds Group's ROE doesn't look that attractive. However, the fact that the company's ROE is higher than the average industry ROE of 6.6%, is definitely interesting. Particularly, the substantial 26% net income growth seen by Rural Funds Group over the past five years is impressive . Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. Therefore, the growth in earnings could also be the result of other factors. E.g the company has a low payout ratio or could belong to a high growth industry.

We then compared Rural Funds Group'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 8.4% 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. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for RFF? You can find out in our latest intrinsic value infographic research report.

Is Rural Funds Group Efficiently Re-investing Its Profits?

Rural Funds Group has a very high three-year median payout ratio of 76%. This means that it has only 24% of its income left to reinvest into its business. However, it's not unusual to see a REIT with such a high payout ratio mainly due to statutory requirements. Regardless, this hasn't hampered its ability to grow as we saw earlier.

Moreover, Rural Funds Group is determined to keep sharing its profits with shareholders which we infer from its long history of seven years of paying a dividend. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 92% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.

Summary

Overall, we feel that Rural Funds Group certainly does have some positive factors to consider. Namely, its significant earnings growth, to which its moderate rate of return likely contributed. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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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