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Could The Market Be Wrong About CareTech Holdings PLC (LON:CTH) Given Its Attractive Financial Prospects?

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CareTech Holdings (LON:CTH) has had a rough three months with its share price down 12%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study CareTech Holdings' 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.

Check out our latest analysis for CareTech Holdings

How Do You Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for CareTech Holdings is:

14% = UK£55m ÷ UK£394m (Based on the trailing twelve months to March 2021).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.14 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

CareTech Holdings' Earnings Growth And 14% ROE

To begin with, CareTech Holdings seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 10%. Probably as a result of this, CareTech Holdings was able to see a decent growth of 16% over the last five years.

We then performed a comparison between CareTech Holdings' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 15% in the same period.

past-earnings-growth
past-earnings-growth

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about CareTech Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is CareTech Holdings Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 56% (or a retention ratio of 44%) for CareTech Holdings suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Moreover, CareTech Holdings is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 32% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.

Conclusion

Overall, we are quite pleased with CareTech Holdings' performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.

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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