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Canadian National Railway Company's (TSE:CNR) Has Had A Decent Run On The Stock market: Are Fundamentals In The Driver's Seat?

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Simply Wall St
·4 min read
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Most readers would already know that Canadian National Railway's (TSE:CNR) stock increased by 5.6% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Canadian National Railway's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Canadian National Railway

How To Calculate Return On Equity?

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 Canadian National Railway is:

18% = CA$3.6b ÷ CA$20b (Based on the trailing twelve months to December 2020).

The 'return' is the yearly profit. Another way to think of that is that for every CA$1 worth of equity, the company was able to earn CA$0.18 in profit.

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. 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.

Canadian National Railway's Earnings Growth And 18% ROE

To begin with, Canadian National Railway seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 15%. However, we are curious as to how Canadian National Railway's decent returns still resulted in flat growth for Canadian National Railway in the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. These include low earnings retention or poor allocation of capital.

As a next step, we compared Canadian National Railway's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 11% in the same period.

past-earnings-growth
past-earnings-growth

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is Canadian National Railway fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Canadian National Railway Efficiently Re-investing Its Profits?

Despite having a normal three-year median payout ratio of 33% (implying that the company keeps 67% of its income) over the last three years, Canadian National Railway has seen a negligible amount of growth in earnings as we saw above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Moreover, Canadian National Railway has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 36% of its profits over the next three years. Regardless, the future ROE for Canadian National Railway is predicted to rise to 23% despite there being not much change expected in its payout ratio.

Conclusion

In total, it does look like Canadian National Railway has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.