Does National HealthCare Corporation's (NYSEMKT:NHC) Weak Fundamentals Mean A Downturn In Its Stock Should Be Expected?

National HealthCare's (NYSEMKT:NHC) stock is up by 2.3% over the past month. However, its weak financial performance indicators makes us a bit doubtful if that trend could continue. Specifically, we decided to study National HealthCare'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for National HealthCare

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 National HealthCare is:

3.6% = US$28m ÷ US$777m (Based on the trailing twelve months to September 2020).

The 'return' is the amount earned after tax over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.04 in profit.

Why Is ROE Important For Earnings Growth?

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

National HealthCare's Earnings Growth And 3.6% ROE

As you can see, National HealthCare's ROE looks pretty weak. Even compared to the average industry ROE of 13%, the company's ROE is quite dismal. Hence, the flat earnings seen by National HealthCare over the past five years could probably be the result of it having a lower ROE.

We then compared National HealthCare's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 8.4% in the same period, which is a bit concerning.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if National HealthCare is trading on a high P/E or a low P/E, relative to its industry.

Is National HealthCare Making Efficient Use Of Its Profits?

National HealthCare has a high three-year median payout ratio of 51% (or a retention ratio of 49%), meaning that the company is paying most of its profits as dividends to its shareholders. This does go some way in explaining why there's been no growth in its earnings.

Moreover, National HealthCare 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.

Summary

On the whole, National HealthCare's performance is quite a big let-down. As a result of its low ROE and lack of mich reinvestment into the business, the company has seen a disappointing earnings growth rate. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. To gain further insights into National HealthCare's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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.
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