It is hard to get excited after looking at ResMed's (NYSE:RMD) recent performance, when its stock has declined 13% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to ResMed'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. 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 ResMed is:
17% = US$500m ÷ US$3.0b (Based on the trailing twelve months to September 2021).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.17 in profit.
Why Is ROE Important For 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 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.
ResMed's Earnings Growth And 17% ROE
To begin with, ResMed seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 9.7%. This probably laid the ground for ResMed's moderate 14% net income growth seen over the past five years.
We then performed a comparison between ResMed's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 14% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Is RMD fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is ResMed Using Its Retained Earnings Effectively?
ResMed has a three-year median payout ratio of 47%, which implies that it retains the remaining 53% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.
Besides, ResMed has been paying dividends over a period of nine years. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 26% over the next three years. The fact that the company's ROE is expected to rise to 23% over the same period is explained by the drop in the payout ratio.
On the whole, we feel that ResMed's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.
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