Most readers would already be aware that Green Cross Health's (NZSE:GXH) stock increased significantly by 11% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Green Cross Health's ROE today.
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 To 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 Green Cross Health is:
13% = NZ$19m ÷ NZ$145m (Based on the trailing twelve months to September 2020).
The 'return' refers to a company's earnings over the last year. So, this means that for every NZ$1 of its shareholder's investments, the company generates a profit of NZ$0.13.
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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.
A Side By Side comparison of Green Cross Health's Earnings Growth And 13% ROE
To start with, Green Cross Health's ROE looks acceptable. Further, the company's ROE is similar to the industry average of 13%. For this reason, Green Cross Health's five year net income decline of 4.9% raises the question as to why the decent ROE didn't translate into growth. So, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.
That being said, we compared Green Cross Health's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 6.3% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Green Cross Health is trading on a high P/E or a low P/E, relative to its industry.
Is Green Cross Health Making Efficient Use Of Its Profits?
While the company did payout a portion of its dividend in the past, it currently doesn't pay a dividend. This implies that potentially all of its profits are being reinvested in the business.
In total, it does look like Green Cross Health has some positive aspects to its business. However, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. So far, we've only made a quick discussion around the company's earnings growth. To gain further insights into Green Cross Health's past profit growth, check out this visualization of past earnings, revenue and cash flows.
If you decide to trade Green Cross Health, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account. Promoted
Valuation is complex, but we're helping make it simple.
Find out whether Green Cross Health is potentially over or undervalued by checking out our comprehensive analysis, which includes fair value estimates, risks and warnings, dividends, insider transactions and financial health.View the Free Analysis
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.