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CAE (TSE:CAE) has had a great run on the share market with its stock up by a significant 8.8% over the last month. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. In this article, we decided to focus on CAE's ROE.
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.
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 CAE is:
0.5% = CA$15m ÷ CA$2.9b (Based on the trailing twelve months to December 2020).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each CA$1 of shareholders' capital it has, the company made CA$0.01 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
CAE's Earnings Growth And 0.5% ROE
It is quite clear that CAE's ROE is rather low. Even compared to the average industry ROE of 8.8%, the company's ROE is quite dismal. Given the circumstances, the significant decline in net income by 5.6% seen by CAE over the last five years is not surprising. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.
As a next step, we compared CAE's performance with the industry and discovered the industry has shrunk at a rate of 13% in the same period meaning that the company has been shrinking its earnings at a rate lower than the industry. This does offer shareholders some relief
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. What is CAE worth today? The intrinsic value infographic in our free research report helps visualize whether CAE is currently mispriced by the market.
Is CAE Efficiently Re-investing Its Profits?
While the company did payout a portion of its dividend in the past, it currently doesn't pay a dividend. This implies that potentially all of its profits are being reinvested in the business.
Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 23% over the next three years.
In total, we're a bit ambivalent about CAE's performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. 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. 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.
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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