Addus HomeCare (NASDAQ:ADUS) has had a rough week with its share price down 19%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Addus HomeCare's ROE in this article.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Is ROE Calculated?
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 Addus HomeCare is:
6.4% = US$33m ÷ US$519m (Based on the trailing twelve months to December 2020).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.06 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. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
Addus HomeCare's Earnings Growth And 6.4% ROE
When you first look at it, Addus HomeCare's ROE doesn't look that attractive. Next, when compared to the average industry ROE of 16%, the company's ROE leaves us feeling even less enthusiastic. Despite this, surprisingly, Addus HomeCare saw an exceptional 26% net income growth over the past five years. Therefore, there could be other reasons behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.
As a next step, we compared Addus HomeCare'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 9.8%.
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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Addus HomeCare's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Addus HomeCare Using Its Retained Earnings Effectively?
In total, it does look like Addus HomeCare has some positive aspects to its business. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
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