Cactus, Inc.'s (NYSE:WHD) Stock Is Going Strong: Is the Market Following Fundamentals?
Cactus' (NYSE:WHD) stock is up by a considerable 14% over the past month. 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. Specifically, we decided to study Cactus' ROE in this article.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. 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 Cactus
How To Calculate Return On Equity?
Return on equity 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 Cactus is:
13% = US$79m ÷ US$615m (Based on the trailing twelve months to March 2022).
The 'return' refers to a company's earnings over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.13 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. 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.
Cactus' Earnings Growth And 13% ROE
To start with, Cactus' ROE looks acceptable. On comparing with the average industry ROE of 5.9% the company's ROE looks pretty remarkable. Despite this, Cactus' five year net income growth was quite low averaging at only 2.1%. That's a bit unexpected from a company which has such a high rate of return. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or poor allocation of capital.
Given that the industry shrunk its earnings at a rate of 3.2% in the same period, the net income growth of the company is quite impressive.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is WHD fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Cactus Efficiently Re-investing Its Profits?
While Cactus has a decent three-year median payout ratio of 41% (or a retention ratio of 59%), it has seen very little growth in earnings. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
In addition, Cactus has been paying dividends over a period of three years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 20% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 23%, over the same period.
Summary
In total, we are pretty happy with Cactus' 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. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.
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.
