Medibank Private (ASX:MPL) stock is up 5.6% over the past three months. As most know, long-term fundamentals have a strong correlation with market price movements, so we decided to take a look at key business financial indicators today to see if they have a role to play. play in the recent price movement. In this article, we have decided to focus on the ROE of Medibank Private.
ROE or return on equity is a useful tool for evaluating how effectively a company can generate returns on the investment it has received from its shareholders. In short, ROE shows the profit that each dollar generates in relation to the investments of its shareholders.
See our latest analysis for Medibank Private
How is ROE calculated?
The return on equity formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for Medibank Private is:
22% = AU$435 million ÷ AU$1.9 billion (based on trailing 12 months to December 2021).
The “yield” is the amount earned after tax over the last twelve months. This means that for every Australian dollar of equity, the company generated a profit of 0.22 Australian dollars.
Why is ROE important for earnings growth?
So far, we have learned that ROE measures how efficiently a company generates its profits. Based on the share of its profits that the company chooses to reinvest or “keep”, we are then able to assess a company’s future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and earnings retention, the higher a company’s growth rate compared to companies that don’t necessarily exhibit these characteristics.
Growth in Medibank Private earnings and ROE of 22%
For starters, Medibank Private has a pretty high ROE which is interesting. Second, a comparison to the average industry-reported ROE of 9.9% also does not go unnoticed by us. For this reason, Medibank Private’s 2.4% decline in net income over five years raises the question of why high ROE has not translated into earnings growth. So there could be other aspects that could explain this. These include poor revenue retention or poor capital allocation.
So, in a next step, we benchmarked Medibank Private’s performance against the industry and were disappointed to find that while the company reduced profits, the industry increased profits at a rate of 6, 9% over the same period.
Earnings growth is an important factor in stock valuation. It is important for an investor to know whether the market has priced in the expected growth (or decline) in the company’s earnings. This will help them determine if the future of the title looks bright or ominous. Has the market priced in MPL’s future prospects? You can find out in our latest infographic research report on intrinsic value.
Does Medibank Private use its profits efficiently?
Medibank Private’s earnings decline is not surprising given that the company spends the bulk of its earnings on paying dividends, judging by its three-year median payout ratio of 85% (or a 15% retention). With only a small portion reinvested in the business, earnings growth would obviously be weak or non-existent.
Moreover, Medibank Private has been paying dividends for seven years, which is a considerable length of time, suggesting that management must have perceived that shareholders preferred consistent dividends even though profits had declined. Based on the latest analyst estimates, we found that the company’s future payout ratio over the next three years is expected to remain stable at 84%. As a result, Medibank Private’s ROE is also not expected to change much, which we inferred from analysts’ estimate of 24% for future ROE.
Overall, we think Medibank Private certainly has positive factors to consider. However, we are disappointed to see a lack of earnings growth, even despite high ROE. Keep in mind that the company reinvests a small portion of its profits, which means that investors do not reap the benefits of the high rate of return. That said, we have studied the latest analyst forecasts and found that although the company has decreased earnings in the past, analysts expect earnings to increase in the future. For more on the company’s future earnings growth forecast, check out this free analyst forecast report for the company to learn more.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.