Target Healthcare REIT's (LON:THRL) stock up by 8.0% over the past three months. However, we decided to study the company's mixed-bag of fundamentals to assess what this could mean for future share prices, as stock prices tend to be aligned with a company's long-term 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Is ROE Calculated?
The formula for return on equity is:
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 yearly profit. That means that for every £1 worth of shareholders' equity, the company generated £0.06 in profit.
Why Is ROE Important For 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.
Target Healthcare REIT's Earnings Growth And 6.4% ROE
At first glance, Target Healthcare REIT's ROE doesn't look very promising. However, its ROE is similar to the industry average of 5.7%, 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 instance, the company has a low payout ratio or is being managed efficiently.
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 9.6%.
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. This then helps them determine if the stock is placed for a bright or bleak future. What is THRL worth today? The intrinsic value infographic in our free research report helps visualize whether THRL is currently mispriced by the market.
Is Target Healthcare REIT Using Its Retained Earnings Effectively?
Target Healthcare REIT's very high three-year median payout ratio of 147% suggests that the company is paying more to its shareholders than what it is earning. In spite of this, the company was able to grow its earnings significantly, as we saw above. Having said that, the high payout ratio is definitely risky and something to keep an eye on.
Moreover, Target Healthcare REIT is determined to keep sharing its profits with shareholders which we infer from its long history of seven years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 92% over the next three years.
In total, we're a bit ambivalent about Target Healthcare REIT'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. So far, we've only made a quick discussion around the company's earnings growth. To gain further insights into Target Healthcare REIT's past profit growth, check out this visualization of past earnings, revenue and cash flows.
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