With its stock down 4.4% over the past month, it is easy to disregard Target Healthcare REIT (LON:THRL). We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on Target Healthcare REIT's ROE.
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.
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 Target Healthcare REIT is:
6.4% = UK£32m ÷ UK£494m (Based on the trailing twelve months to June 2020).
The 'return' is the profit over the last twelve months. That means that for every £1 worth of shareholders' equity, the company generated £0.06 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.
Target Healthcare REIT's Earnings Growth And 6.4% ROE
When you first look at it, Target Healthcare REIT's ROE doesn't look that attractive. However, its ROE is similar to the industry average of 5.3%, so we won't completely dismiss the company. Particularly, the exceptional 22% net income growth seen by Target Healthcare REIT over the past five years is pretty remarkable. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. 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 Target Healthcare REIT's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 8.3%.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is THRL fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Target Healthcare REIT Efficiently Re-investing Its Profits?
The really high three-year median payout ratio of 147% for Target Healthcare REIT suggests that the company is paying its shareholders more than what it is earning. However, this hasn't hampered its ability to grow as we saw earlier. Although, it could be worth keeping an eye on the high payout ratio as that's a huge risk.
Besides, Target Healthcare REIT has been paying dividends over a period of seven years. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 78% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.
Overall, we have mixed feelings about Target Healthcare REIT. 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. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. So it may be worth checking this free detailed graph of Target Healthcare REIT's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.
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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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