Canadian National Railway Company's (TSE:CNR) Has Had A Decent Run On The Stock market: Are Fundamentals In The Driver's Seat?
Most readers would already know that Canadian National Railway's (TSE:CNR) stock increased by 2.8% over the past month. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to investigate if the company's decent financials had a hand to play in the recent price move. Specifically, we decided to study Canadian National Railway's ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
See our latest analysis for Canadian National Railway
How Do You Calculate Return On Equity?
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 Canadian National Railway is:
26% = CA$5.3b ÷ CA$20b (Based on the trailing twelve months to June 2023).
The 'return' is the amount earned after tax over the last twelve months. That means that for every CA$1 worth of shareholders' equity, the company generated CA$0.26 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 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.
A Side By Side comparison of Canadian National Railway's Earnings Growth And 26% ROE
To begin with, Canadian National Railway has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 18% which is quite remarkable. However, we are curious as to how the high returns still resulted in a flat growth for Canadian National Railway in the past five years. We reckon that there could be some other factors at play here that's limiting 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.
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. Is CNR fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Canadian National Railway Using Its Retained Earnings Effectively?
Despite having a normal three-year median payout ratio of 39% (implying that the company keeps 61% of its income) over the last three years, Canadian National Railway has seen a negligible amount of growth in earnings as we saw above. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
In addition, Canadian National Railway has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 38% of its profits over the next three years. As a result, Canadian National Railway's ROE is not expected to change by much either, which we inferred from the analyst estimate of 30% for future ROE.
Summary
On the whole, we do feel that Canadian National Railway has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.
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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.
