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Canadian National Railway Company's (TSE:CNR) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

Canadian National Railway (TSE:CNR) has had a rough week with its share price down 3.6%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on Canadian National Railway's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Canadian National Railway

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Canadian National Railway is:

22% = CA$4.9b ÷ CA$23b (Based on the trailing twelve months to December 2021).

The 'return' is the profit over the last twelve months. So, this means that for every CA$1 of its shareholder's investments, the company generates a profit of CA$0.22.

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 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.

Canadian National Railway's Earnings Growth And 22% ROE

To start with, Canadian National Railway's ROE looks acceptable. Especially when compared to the industry average of 8.4% the company's ROE looks pretty impressive. Given the circumstances, we can't help but wonder why Canadian National Railway saw little to no growth 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. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

We then compared Canadian National Railway's net income growth with the industry and found that the average industry growth rate was 11% in the same period.

past-earnings-growth
past-earnings-growth

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. Has the market priced in the future outlook for CNR? You can find out in our latest intrinsic value infographic research report.

Is Canadian National Railway Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 36% (or a retention ratio of 64%), Canadian National Railway hasn't seen much growth in its earnings. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, Canadian National Railway has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no 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 27% despite there being not much change expected in its payout ratio.

Summary

Overall, we feel that Canadian National Railway certainly does have some positive factors to consider. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.

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