National HealthCare Corporation's (NYSEMKT:NHC) Stock Going Strong But Fundamentals Look Weak: What Implications Could This Have On The Stock?

National HealthCare's (NYSEMKT:NHC) stock is up by a considerable 14% over the past three months. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimatley dictates market outcomes. In this article, we decided to focus on National HealthCare's ROE.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for National HealthCare

How Do You 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 National HealthCare is:

5.3% = US$42m ÷ US$798m (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 $0.05 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

National HealthCare's Earnings Growth And 5.3% ROE

At first glance, National HealthCare's ROE doesn't look very promising. Next, when compared to the average industry ROE of 15%, the company's ROE leaves us feeling even less enthusiastic. As a result, National HealthCare's flat net income growth over the past five years doesn't come as a surprise given its lower ROE.

As a next step, we compared National HealthCare's net income growth with the industry and discovered that the industry saw an average growth of 9.8% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. 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?

With a high three-year median payout ratio of 51% (implying that the company keeps only 49% of its income) of its business to reinvest into its business), most of National HealthCare's profits are being paid to shareholders, which explains the absence of growth in earnings.

Additionally, National HealthCare 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

On the whole, National HealthCare's performance is quite a big let-down. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. 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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