It is hard to get excited after looking at U.S. Physical Therapy's (NYSE:USPH) recent performance, when its stock has declined 11% over the past month. 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 U.S. Physical Therapy'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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Is ROE Calculated?

ROE 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 U.S. Physical Therapy is:

4.7% = US$32m ÷ US$671m (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.05 in profit.

Why Is ROE Important For 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.

A Side By Side comparison of U.S. Physical Therapy's Earnings Growth And 4.7% ROE

When you first look at it, U.S. Physical Therapy's ROE doesn't look that attractive. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 13%. For this reason, U.S. Physical Therapy's five year net income decline of 9.9% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared U.S. Physical Therapy's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 6.3% in the same period. This is quite worrisome.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 U.S. Physical Therapy's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is U.S. Physical Therapy Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 77% (implying that 23% of the profits are retained), most of U.S. Physical Therapy's profits are being paid to shareholders, which explains the company's shrinking earnings. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. To know the 4 risks we have identified for U.S. Physical Therapy visit our risks dashboard for free.

In addition, U.S. Physical Therapy has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 56% over the next three years. The fact that the company's ROE is expected to rise to 9.8% over the same period is explained by the drop in the payout ratio.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning U.S. Physical Therapy. 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. 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.

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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.