It is hard to get excited after looking at Encompass Health's (NYSE:EHC) recent performance, when its stock has declined 4.4% over the past month. 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 Encompass Health's ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

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 Encompass Health is:

21% = US$599m ÷ US$2.8b (Based on the trailing twelve months to December 2024).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.21 in profit.

See our latest analysis for Encompass Health

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

A Side By Side comparison of Encompass Health's Earnings Growth And 21% ROE

To begin with, Encompass Health seems to have a respectable ROE. On comparing with the average industry ROE of 11% the company's ROE looks pretty remarkable. This certainly adds some context to Encompass Health's decent 7.8% net income growth seen over the past five years.

As a next step, we compared Encompass Health's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 4.1%.

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 Encompass Health's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Encompass Health Using Its Retained Earnings Effectively?

In Encompass Health's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 18% (or a retention ratio of 82%), which suggests that the company is investing most of its profits to grow its business.

Moreover, Encompass Health 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 12% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.

Conclusion

In total, we are pretty happy with Encompass Health's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.