Ramsay Health Care (ASX:RHC) has had a rough month with its share price down 6.5%. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. In this article, we decided to focus on Ramsay Health Care'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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

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How Is ROE Calculated?

Return on equity can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Ramsay Health Care is:

0.5% = AU$29m ÷ AU$5.4b (Based on the trailing twelve months to December 2024).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.01 in profit.

See our latest analysis for Ramsay Health Care

What Has ROE Got To Do With Earnings Growth?

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

Ramsay Health Care's Earnings Growth And 0.5% ROE

It is quite clear that Ramsay Health Care's ROE is rather low. Even compared to the average industry ROE of 3.8%, the company's ROE is quite dismal. Given the circumstances, the significant decline in net income by 17% seen by Ramsay Health Care over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

Next, on comparing with the industry net income growth, we found that Ramsay Health Care's earnings seems to be shrinking at a similar rate as the industry which shrunk at a rate of a rate of 19% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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 Ramsay Health Care fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Ramsay Health Care Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 85% (implying that 15% of the profits are retained), most of Ramsay Health Care's profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. You can see the 3 risks we have identified for Ramsay Health Care by visiting our risks dashboard for free on our platform here.

Additionally, Ramsay Health Care 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 64% over the next three years. As a result, the expected drop in Ramsay Health Care's payout ratio explains the anticipated rise in the company's future ROE to 9.2%, over the same period.

Summary

Overall, we would be extremely cautious before making any decision on Ramsay Health Care. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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.