Medifast's (NYSE:MED) stock is up by a considerable 18% over the past month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Medifast's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How To 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 Medifast is:
68% = US$95m ÷ US$140m (Based on the trailing twelve months to September 2020).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.68 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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
A Side By Side comparison of Medifast's Earnings Growth And 68% ROE
Firstly, we acknowledge that Medifast has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 16% which is quite remarkable. Under the circumstances, Medifast's considerable five year net income growth of 37% was to be expected.
As a next step, we compared Medifast'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 15%.
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 Medifast's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Medifast Using Its Retained Earnings Effectively?
Medifast's significant three-year median payout ratio of 52% (where it is retaining only 48% of its income) suggests that the company has been able to achieve a high growth in earnings despite returning most of its income to shareholders.
Additionally, Medifast has paid dividends over a period of five years which means that the company is pretty serious about sharing its profits with shareholders.
On the whole, we feel that Medifast's performance has been quite good. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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. 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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