Is Third Age Health Services Limited's (NZSE:TAH) Stock's Recent Performance Being Led By Its Attractive Financial Prospects?

Most readers would already be aware that Third Age Health Services' (NZSE:TAH) stock increased significantly by 41% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Third Age Health Services' ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Third Age Health Services

How Do You 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 Third Age Health Services is:

55% = NZ$2.0m ÷ NZ$3.6m (Based on the trailing twelve months to September 2024).

The 'return' is the profit over the last twelve months. That means that for every NZ$1 worth of shareholders' equity, the company generated NZ$0.55 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Third Age Health Services' Earnings Growth And 55% ROE

To begin with, Third Age Health Services has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 11% which is quite remarkable. Yet, Third Age Health Services has posted measly growth of 4.8% over the past five years. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn't been able to do so. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

Next, on comparing with the industry net income growth, we found that Third Age Health Services' growth is quite high when compared to the industry average growth of 2.7% in the same period, which is great to see.

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. 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 Third Age Health Services is trading on a high P/E or a low P/E, relative to its industry.

Is Third Age Health Services Making Efficient Use Of Its Profits?

Third Age Health Services has a three-year median payout ratio of 78% (implying that it keeps only 22% of its profits), meaning that it pays out most of its profits to shareholders as dividends, and as a result, the company has seen low earnings growth.

In addition, Third Age Health Services has been paying dividends over a period of four years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Summary

Overall, we are quite pleased with Third Age Health Services' performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. 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. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. To know the 3 risks we have identified for Third Age Health Services visit our risks dashboard for free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.