With its stock down 12% over the past three months, it is easy to disregard Healthcare Services Group (NASDAQ:HCSG). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Healthcare Services Group's ROE today.
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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Do You 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 Healthcare Services Group is:
15% = US$72m ÷ US$480m (Based on the trailing twelve months to September 2021).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.15 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. 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.
Healthcare Services Group's Earnings Growth And 15% ROE
To begin with, Healthcare Services Group seems to have a respectable ROE. Especially when compared to the industry average of 11% the company's ROE looks pretty impressive. Yet, Healthcare Services Group has posted measly growth of 2.8% 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. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or poor allocation of capital.
As a next step, we compared Healthcare Services Group's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is HCSG worth today? The intrinsic value infographic in our free research report helps visualize whether HCSG is currently mispriced by the market.
Is Healthcare Services Group Using Its Retained Earnings Effectively?
With a high three-year median payout ratio of 69% (or a retention ratio of 31%), most of Healthcare Services Group's profits are being paid to shareholders. This definitely contributes to the low earnings growth seen by the company.
Moreover, Healthcare Services Group has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 92% over the next three years. However, the company's ROE is not expected to change by much despite the higher expected payout ratio.
On the whole, we do feel that Healthcare Services Group has some positive attributes. 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. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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.