Welltower (NYSE:WELL) has had a great run on the share market with its stock up by a significant 13% over the last three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Particularly, we will be paying attention to Welltower's ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Do You Calculate Return On Equity?
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:
2.0% = US$374m ÷ US$19b (Based on the trailing twelve months to December 2021).
The 'return' is the yearly profit. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.02 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. 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. 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.
Welltower's Earnings Growth And 2.0% ROE
It is hard to argue that Welltower's ROE is much good in and of itself. Not just that, even compared to the industry average of 6.9%, the company's ROE is entirely unremarkable. For this reason, Welltower's five year net income decline of 4.5% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.
That being said, we compared Welltower's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 11% in the same period.
Earnings growth is an important metric to consider when valuing a stock. 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. What is WELL worth today? The intrinsic value infographic in our free research report helps visualize whether WELL is currently mispriced by the market.
Is Welltower Using Its Retained Earnings Effectively?
Welltower seems to be paying out most of its income as dividends judging by its three-year median payout ratio of 94% (meaning, the company retains only 5.8% of profits). However, this is typical for REITs as they are often required by law to distribute most of their earnings. So this probably explains the company's shrinking earnings.
In addition, Welltower has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 63% over the next three years. The fact that the company's ROE is expected to rise to 4.5% over the same period is explained by the drop in the payout ratio.
In total, we would have a hard think before deciding on any investment action concerning Welltower. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. 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. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
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.