Chemed Corporation's (NYSE:CHE) Has Had A Decent Run On The Stock market: Are Fundamentals In The Driver's Seat?

Chemed's (NYSE:CHE) stock is up by 9.5% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to investigate if the company's decent financials had a hand to play in the recent price move. In this article, we decided to focus on Chemed's ROE.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Chemed

How Do You 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 Chemed is:

25% = US$301m ÷ US$1.2b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.25.

What Is The Relationship Between ROE And 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 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.

Chemed's Earnings Growth And 25% ROE

First thing first, we like that Chemed has an impressive ROE. Secondly, even when compared to the industry average of 13% the company's ROE is quite impressive. However, for some reason, the higher returns aren't reflected in Chemed's meagre five year net income growth average of 2.4%. 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 or poor allocation of capital.

As a next step, we compared Chemed'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 6.2% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Chemed's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Chemed Using Its Retained Earnings Effectively?

Chemed has a low three-year median payout ratio of 8.4% (meaning, the company keeps the remaining 92% of profits) which means that the company is retaining more of its earnings. This should be reflected in its earnings growth number, but that's not the case. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, Chemed has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Conclusion

Overall, we feel that Chemed certainly does have some positive factors to consider. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.