Declining Stock and Solid Fundamentals: Is The Market Wrong About McGrath RentCorp (NASDAQ:MGRC)?

With its stock down 8.3% over the past week, it is easy to disregard McGrath RentCorp (NASDAQ:MGRC). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to McGrath RentCorp's ROE today.

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.

Check out our latest analysis for McGrath RentCorp

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 McGrath RentCorp is:

15% = US$97m ÷ US$662m (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.15 in profit.

What Has ROE Got To Do With 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 McGrath RentCorp's Earnings Growth And 15% ROE

At first glance, McGrath RentCorp seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 12%. This certainly adds some context to McGrath RentCorp's decent 19% net income growth seen over the past five years.

We then performed a comparison between McGrath RentCorp's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 17% 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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for MGRC? You can find out in our latest intrinsic value infographic research report.

Is McGrath RentCorp Efficiently Re-investing Its Profits?

McGrath RentCorp has a three-year median payout ratio of 38%, which implies that it retains the remaining 62% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Besides, McGrath RentCorp has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 38%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 16%.

Summary

On the whole, we feel that McGrath RentCorp's performance has been quite good. 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. 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. 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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