Castings P.L.C. (LON:CGS) Is Going Strong But Fundamentals Appear To Be Mixed : Is There A Clear Direction For The Stock?
Most readers would already be aware that Castings' (LON:CGS) stock increased significantly by 11% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to Castings' ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
See our latest analysis for Castings
How Is ROE Calculated?
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 Castings is:
10% = UK£14m ÷ UK£132m (Based on the trailing twelve months to March 2023).
The 'return' refers to a company's earnings over the last year. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.10.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
Castings' Earnings Growth And 10% ROE
To begin with, Castings seems to have a respectable ROE. Yet, the fact that the company's ROE is lower than the industry average of 13% does temper our expectations. On further research, we found that Castings' earnings over the past five years have been pretty flat. Bear in mind, the company does have a respectable level of ROE. It is just that the industry ROE is higher. Therefore, the flat earnings growth could be the result of other factors. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitve pressures.
We then compared Castings' net income growth with the industry and found that the average industry growth rate was 19% in the same 5-year period.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for CGS? You can find out in our latest intrinsic value infographic research report.
Is Castings Using Its Retained Earnings Effectively?
With a high three-year median payout ratio of 78% (implying that the company keeps only 22% of its income) of its business to reinvest into its business), most of Castings' profits are being paid to shareholders, which explains the absence of growth in earnings.
Moreover, Castings 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. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 51% over the next three years.
Conclusion
On the whole, we feel that the performance shown by Castings can be open to many interpretations. On the one hand, the company does have a decent rate of return, however, its earnings growth number is quite disappointing and as discussed earlier, the low retained earnings is hampering the 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. 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.
