With its stock down 20% over the past three months, it is easy to disregard Radius Residential Care (NZSE: RAD). To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. Particularly, we will be paying attention to Radius Residential Care’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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
View our latest analysis for Radius Residential Care
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 Radius Residential Care is:
1.4% = NZ $ 974k ÷ NZ $ 70m (Based on the trailing twelve months to September 2021).
The ‘return’ is the profit over the last twelve months. Another way to think of that is that for every NZ $ 1 worth of equity, the company was able to earn NZ $ 0.01 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 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 Radius Residential Care’s Earnings Growth And 1.4% ROE
As you can see, Radius Residential Care’s ROE looks pretty weak. Even when compared to the industry average of 16%, the ROE figure is pretty disappointing. Therefore, it might not be wrong to say that the five year net income decline of 37% seen by Radius Residential Care was possibly a result of it having a lower ROE. We believe that there may also be other aspects that are negatively influencing the company’s earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
So, as a next step, we compared Radius Residential Care’s performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 14% in the same period.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is RAD worth today? The intrinsic value infographic in our free research report helps visualize whether RAD is currently mispriced by the market.
Is Radius Residential Care Using Its Retained Earnings Effectively?
Radius Residential Care’s declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 96% (or a retention ratio of 3.5%). With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. You can see the 6 risks we have identified for Radius Residential Care by visiting our risks dashboard for free on our platform here.
Additionally, Radius Residential Care started paying a dividend only recently. So it looks like the management may have perceived that shareholders favor dividends even though earnings have been in decline.
Overall, we would be extremely cautious before making any decision on Radius Residential Care. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. So far, we’ve only made a quick discussion around the company’s earnings growth. To gain further insights into Radius Residential Care’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. 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.