With its stock down 17% over the past week, it is easy to disregard Mayfield Childcare (ASX:MFD). It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Specifically, we decided to study Mayfield Childcare's ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
See our latest analysis for Mayfield Childcare
How Do You Calculate Return On Equity?
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 Mayfield Childcare is:
5.5% = AU$3.7m ÷ AU$68m (Based on the trailing twelve months to June 2022).
The 'return' is the yearly profit. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.06 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
Mayfield Childcare's Earnings Growth And 5.5% ROE
On the face of it, Mayfield Childcare's ROE is not much to talk about. However, the fact that the its ROE is quite higher to the industry average of 3.7% doesn't go unnoticed by us. But then again, seeing that Mayfield Childcare's net income shrunk at a rate of 2.8% in the past five years, makes us think again. Remember, the company's ROE is a bit low to begin with, just that it is higher than the industry average. Therefore, the decline in earnings could also be the result of this.
That being said, we compared Mayfield Childcare's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 0.8% in the same period.
Earnings growth is an important metric to consider when valuing a stock. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for MFD? You can find out in our latest intrinsic value infographic research report
Is Mayfield Childcare Efficiently Re-investing Its Profits?
With a high three-year median payout ratio of 63% (implying that 37% of the profits are retained), most of Mayfield Childcare's profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely. Our risks dashboard should have the 4 risks we have identified for Mayfield Childcare.
In addition, Mayfield Childcare has been paying dividends over a period of five years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline.
On the whole, we feel that the performance shown by Mayfield Childcare can be open to many interpretations. Primarily, we are disappointed to see a lack of growth in earnings even in spite of a moderate ROE. Bear in mind, the company reinvests a small portion of its profits, which explains the lack of growth. 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 latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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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