Welltower (NYSE:WELL) has had a great run on the share market with its stock up by a significant 18% over the last three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. In this article, we decided to focus on Welltower'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.
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Welltower is:
4.6% = US$782m ÷ US$17b (Based on the trailing twelve months to March 2021).
The 'return' is the income the business earned over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.05.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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.
Welltower's Earnings Growth And 4.6% ROE
When you first look at it, Welltower's ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 5.1%, we may spare it some thought. Even so, Welltower has shown a fairly decent growth in its net income which grew at a rate of 5.1%. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
Next, on comparing with the industry net income growth, we found that Welltower's reported growth was lower than the industry growth of 9.9% in the same period, which is not something we like to see.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is WELL fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Welltower Making Efficient Use Of Its Profits?
Welltower has a high three-year median payout ratio of 97%. This means that it has only 3.1% of its income left to reinvest into its business. However, it's not unusual to see a REIT with such a high payout ratio mainly due to statutory requirements. In spite of this, the company was able to grow its earnings by a fair bit, as we saw above.
Moreover, Welltower is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 71% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.
On the whole, we feel that the performance shown by Welltower can be open to many interpretations. Although the company has shown a fair bit of growth in earnings, the reinvestment rate is low. Meaning, the earnings growth number could have been significantly higher had the company been retaining more of its profits and reinvesting that at a higher rate of return. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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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