Most readers would already be aware that Vital Healthcare Property Trust's (NZSE:VHP) stock increased significantly by 21% over the past month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Vital Healthcare Property Trust's ROE.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How To 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 Vital Healthcare Property Trust is:
9.7% = NZ$104m ÷ NZ$1.1b (Based on the trailing twelve months to December 2019).
The 'return' is the income the business earned over the last year. So, this means that for every NZ$1 of its shareholder's investments, the company generates a profit of NZ$0.10.
Why Is ROE Important For Earnings Growth?
Thus far, we have learnt that ROE measures how efficiently a company is generating its profits. 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.
A Side By Side comparison of Vital Healthcare Property Trust's Earnings Growth And 9.7% ROE
To begin with, Vital Healthcare Property Trust seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 9.9%. Vital Healthcare Property Trust's decent returns aren't reflected in Vital Healthcare Property Trust'smediocre five year net income growth average of 4.6%. We reckon that a low growth, when returns are moderate could be the result of certain circumstances like low earnings retention or poor allocation of capital.
We then compared Vital Healthcare Property Trust's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 9.8% in the same period, which is a bit concerning.
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. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for VHP? You can find out in our latest intrinsic value infographic research report.
Is Vital Healthcare Property Trust Making Efficient Use Of Its Profits?
Vital Healthcare Property Trust has a very high three-year median payout ratio of70%, implying that it retains only 30% of its profits. However, it's not unusual to see a REIT with such a high payout ratio mainly due to statutory requirements. Accordingly, this suggests that the company's earnings growth was lower as a result of the high payout.
In addition, Vital Healthcare Property Trust 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 over the next three years is expected to be approximately 71%. Still, forecasts suggest that Vital Healthcare Property Trust's future ROE will drop to 5.0% even though the the company's payout ratio is not expected to change by much.
In total, it does look like Vital Healthcare Property Trust has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. 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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