carsales.com Ltd (ASX:CAR) Stock's Been Sliding But Fundamentals Look Decent: Will The Market Correct The Share Price In The Future?
With its stock down 1.4% over the past three months, it is easy to disregard carsales.com (ASX:CAR). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on carsales.com'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 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 carsales.com
How Do You 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 carsales.com is:
14% = AU$131m ÷ AU$941m (Based on the trailing twelve months to June 2021).
The 'return' is the yearly profit. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.14.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
carsales.com's Earnings Growth And 14% ROE
To begin with, carsales.com seems to have a respectable ROE. Be that as it may, the company's ROE is still quite lower than the industry average of 21%. Additionally, the flat earnings seen by carsales.com over the past five years doesn't paint a very bright picture. Not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So there might be other reasons for the flat earnings growth. For example, it could be that the company has a high payout ratio or the business has alloacted capital, for instance.
As a next step, we compared carsales.com's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 1.8% 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about carsales.com's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is carsales.com Using Its Retained Earnings Effectively?
The high three-year median payout ratio of 84% (meaning, the company retains only 16% of profits) for carsales.com suggests that the company's earnings growth was miniscule as a result of paying out a majority of its earnings.
In addition, carsales.com 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 80% of its profits over the next three years. Regardless, the future ROE for carsales.com is predicted to rise to 23% despite there being not much change expected in its payout ratio.
Summary
In total, it does look like carsales.com has some positive aspects to its business. True, the company has posted a respectable growth in earnings. However, the earnings growth number could have been even higher, had the company been reinvesting more of its earnings and paying out less dividends. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.
