Dedicare (STO:DEDI) has had a rough month with its share price down 14%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study Dedicare’s ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder’s equity.
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How Is ROE Calculated?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for Dedicare is:
42% = kr84m ÷ kr199m (Based on the trailing twelve months to June 2022).
The ‘return’ is the income the business earned over the last year. That means that for every SEK1 worth of shareholders’ equity, the company generated SEK0.42 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. Based on how much of its profits the company chooses to reinvest or “retain”, we are then able to evaluate a company’s future ability to generate profits. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Dedicare’s Earnings Growth And 42% ROE
To begin with, Dedicare has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 7.9% the company’s ROE is quite impressive. Despite this, Dedicare’s five year net income growth was quite low averaging at only 3.7%. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or or poor allocation of capital.
Next, on comparing with the industry net income growth, we found that Dedicare’s reported growth was lower than the industry growth of 4.9% in the same period, which is not something we like to see.
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. Doing so will help them establish if the stock’s future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Dedicare is trading on a high P/E or a low P/E, relative to its industry.
Is Dedicare Making Efficient Use Of Its Profits?
The high three-year median payout ratio of 56% (that is, the company retains only 44% of its income) over the past three years for Dedicare suggests that the company’s earnings growth was lower as a result of paying out a majority of its earnings.
Additionally, Dedicare has paid dividends over a period of at least ten years, which means that the company’s management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 50%. As a result, Dedicare’s ROE is not expected to change by much either, which we inferred from the analyst estimate of 34% for future ROE.
Conclusion
On the whole, we do feel that Dedicare has some positive attributes. 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. Having said that, looking at the current analyst estimates, we found that the company’s earnings are expected to gain momentum. 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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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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