Yahoo Finance M.D.C. Holdings, Inc.'s (NYSE:MDC) Stock Is Going Strong: Is the Market Following Fundamentals?
Most readers would already be aware that M.D.C. Holdings' (NYSE:MDC) stock increased significantly by 17% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on M.D.C. Holdings' 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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
View our latest analysis for M.D.C. Holdings
How Is ROE Calculated?
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 M.D.C. Holdings is:
21% = US$645m ÷ US$3.0b (Based on the trailing twelve months to September 2022).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.21 in profit.
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.
M.D.C. Holdings' Earnings Growth And 21% ROE
At first glance, M.D.C. Holdings seems to have a decent ROE. Even when compared to the industry average of 23% the company's ROE looks quite decent. This probably goes some way in explaining M.D.C. Holdings' significant 33% net income growth over the past five years amongst other factors. We reckon that there could also be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.
We then performed a comparison between M.D.C. Holdings' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 30% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if M.D.C. Holdings is trading on a high P/E or a low P/E, relative to its industry.
Is M.D.C. Holdings Efficiently Re-investing Its Profits?
M.D.C. Holdings' three-year median payout ratio to shareholders is 23%, which is quite low. This implies that the company is retaining 77% of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.
Moreover, M.D.C. 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. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 73% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 5.8% over the same period.
Summary
On the whole, we feel that M.D.C. Holdings' performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. 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.
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