Most readers would already know that Chemed's (NYSE:CHE) stock increased by 4.2% 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 Chemed's ROE.

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.

Check out our latest analysis for Chemed

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 Chemed is:

24% = US$302m ÷ US$1.2b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.24 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

Chemed's Earnings Growth And 24% ROE

To begin with, Chemed has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 13% which is quite remarkable. Given the circumstances, we can't help but wonder why Chemed saw little to no growth in the past five years. So, there could be some other aspects that could potentially be preventing the company from growing. These include low earnings retention or poor allocation of capital

We then compared Chemed's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 5.7% in the same 5-year 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is CHE worth today? The intrinsic value infographic in our free research report helps visualize whether CHE is currently mispriced by the market.

Is Chemed Using Its Retained Earnings Effectively?

Chemed's low three-year median payout ratio of 8.5%, (meaning the company retains92% of profits) should mean that the company is retaining most of its earnings and consequently, should see higher growth than it has reported.

Moreover, Chemed has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

On the whole, we do feel that Chemed has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.