Capital Drilling Limited's (LON:CAPD) Stock Is Going Strong: Is the Market Following Fundamentals?
Capital Drilling's's (LON:CAPD) stock is up by a considerable 16% over the past month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Capital Drilling's ROE.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
View our latest analysis for Capital Drilling
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 Capital Drilling is:
12% = US$10m ÷ US$87m (Based on the trailing twelve months to December 2019).
The 'return' is the profit over the last twelve months. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.12.
What Has ROE Got To Do With Earnings Growth?
So far, we've learnt 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.
Capital Drilling's Earnings Growth And 12% ROE
To begin with, Capital Drilling seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 7.1%. This certainly adds some context to Capital Drilling's exceptional 64% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.
We then compared Capital Drilling's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 47% in the same period.
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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Capital Drilling's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Capital Drilling Making Efficient Use Of Its Profits?
Capital Drilling's ' LTM (or last twelve month) payout ratio is on the lower side at 18% implying that it is retaining a higher percentage (82%) of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.
Additionally, Capital Drilling has paid dividends over a period of five years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 31% over the next three years.
Conclusion
In total, we are pretty happy with Capital Drilling's 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. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. Our risks dashboard would have the 2 risks we have identified for Capital Drilling.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.
