Should Weakness in Universal Health Services, Inc.'s (NYSE:UHS) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

With its stock down 18% over the past three months, it is easy to disregard Universal Health Services (NYSE:UHS). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Universal Health Services' 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Universal Health Services

How To 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 Universal Health Services is:

16% = US$1.0b ÷ US$6.7b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.16 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

A Side By Side comparison of Universal Health Services' Earnings Growth And 16% ROE

At first glance, Universal Health Services seems to have a decent ROE. On comparing with the average industry ROE of 13% the company's ROE looks pretty remarkable. Despite this, Universal Health Services' five year net income growth was quite flat over the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

Next, on comparing with the industry net income growth, we found that the industry grew its earnings by 6.3% over the last few years.

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. Is Universal Health Services fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Universal Health Services Efficiently Re-investing Its Profits?

Universal Health Services has a low three-year median payout ratio of 7.7% (or a retention ratio of 92%) but the negligible earnings growth number doesn't reflect this as high growth usually follows high profit retention.

Moreover, Universal Health Services 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. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 4.2% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.

Conclusion

In total, it does look like Universal Health Services has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. 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 company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.