Does The Market Have A Low Tolerance For Residential Secure Income plc's (LON:RESI) Mixed Fundamentals?

It is hard to get excited after looking at Residential Secure Income's (LON:RESI) recent performance, when its stock has declined 1.8% over the past three months. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Particularly, we will be paying attention to Residential Secure Income'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Residential Secure Income

How Do You Calculate Return On Equity?

Return on equity 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 Residential Secure Income is:

1.4% = UK£2.4m ÷ UK£180m (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. That means that for every £1 worth of shareholders' equity, the company generated £0.01 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

A Side By Side comparison of Residential Secure Income's Earnings Growth And 1.4% ROE

As you can see, Residential Secure Income's ROE looks pretty weak. Even when compared to the industry average of 5.7%, the ROE figure is pretty disappointing. However, the moderate 9.0% net income growth seen by Residential Secure Income over the past five years is definitely a positive. We reckon that there could be other factors at play here. 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 Residential Secure Income's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 9.6% in the same period.

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. If you're wondering about Residential Secure Income's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Residential Secure Income Efficiently Re-investing Its Profits?

Residential Secure Income's high three-year median payout ratio of 117% suggests that the company is paying out more to its shareholders than what it is making. In spite of this, the company was able to grow its earnings respectably, as we saw above. Although, the high payout ratio is certainly something we would keep an eye on if the company is not able to keep up its growth, or if business deteriorates. To know the 4 risks we have identified for Residential Secure Income visit our risks dashboard for free.

Moreover, Residential Secure Income is determined to keep sharing its profits with shareholders which we infer from its long history of three years of paying a dividend. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 96%. Regardless, the future ROE for Residential Secure Income is predicted to rise to 3.9% despite there being not much change expected in its payout ratio.

Conclusion

In total, we're a bit ambivalent about Residential Secure Income's performance. While the company has posted impressive earnings growth, its poor ROE and low earnings retention makes us doubtful if that growth could continue, if by any chance the business is faced with any sort of risk. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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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