Can Vital Healthcare Property Trust's (NZSE:VHP) Weak Financials Pull The Plug On The Stock's Current Momentum On Its Share Price?

Vital Healthcare Property Trust (NZSE:VHP) has had a great run on the share market with its stock up by a significant 13% over the last three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. In this article, we decided to focus on Vital Healthcare Property Trust's ROE.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Vital Healthcare Property Trust

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Vital Healthcare Property Trust is:

5.4% = NZ$58m ÷ NZ$1.1b (Based on the trailing twelve months to June 2020).

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$0.05 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Vital Healthcare Property Trust's Earnings Growth And 5.4% ROE

At first glance, Vital Healthcare Property Trust's ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 8.4%. Given the circumstances, the significant decline in net income by 7.6% seen by Vital Healthcare Property Trust over the last five years is not surprising. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

That being said, we compared Vital Healthcare Property Trust'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 10% in the same period.

Earnings growth is a huge factor in stock valuation. 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. Is Vital Healthcare Property Trust fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Vital Healthcare Property Trust Efficiently Re-investing Its Profits?

Vital Healthcare Property Trust has a very high three-year median payout ratio of 71%, implying that it retains only 29% of its profits. However, it's not unusual to see a REIT with such a high payout ratio mainly due to statutory requirements. Accordingly, this likely explains why its earnings have been shrinking.

In addition, Vital Healthcare Property Trust has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. 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 78%. Accordingly, forecasts suggest that Vital Healthcare Property Trust's future ROE will be 4.8% which is again, similar to the current ROE.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Vital Healthcare Property Trust. As a result of its low ROE and lack of mich reinvestment into the business, the company has seen a disappointing earnings growth rate. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

If you’re looking to trade Vital Healthcare Property Trust, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account. Promoted

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.