Ramsay Health Care's (ASX:RHC) stock is up by a considerable 18% over the past three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Particularly, we will be paying attention to Ramsay Health Care'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.

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How To Calculate Return On Equity?

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' refers to a company's earnings over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.01.

See our latest analysis for Ramsay Health Care

What Has ROE Got To Do With 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.

Ramsay Health Care's Earnings Growth And 0.5% ROE

As you can see, Ramsay Health Care's ROE looks pretty weak. Not just that, even compared to the industry average of 3.0%, the company's ROE is entirely unremarkable. For this reason, Ramsay Health Care's five year net income decline of 17% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

With the industry earnings declining at a rate of 19% in the same period, we deduce that both the company and the industry are shrinking at the same rate.

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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Ramsay Health Care's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Ramsay Health Care Making Efficient Use Of Its Profits?

Ramsay Health Care's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 85% (or a retention ratio of 15%). With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. To know the 3 risks we have identified for Ramsay Health Care visit our risks dashboard for free.

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. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 63% 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 9.1%, over the same period.

Conclusion

On the whole, Ramsay Health Care's performance is quite a big let-down. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.