Chemring Group PLC's (LON:CHG) Stock Is Going Strong: Is the Market Following Fundamentals?
Chemring Group's (LON:CHG) stock is up by a considerable 23% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Particularly, we will be paying attention to Chemring Group's 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.
View our latest analysis for Chemring Group
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 Chemring Group is:
10.0% = UK£38m ÷ UK£379m (Based on the trailing twelve months to October 2023).
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 £0.10.
What Is The Relationship Between ROE And 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 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.
Chemring Group's Earnings Growth And 10.0% ROE
To start with, Chemring Group's ROE looks acceptable. Further, the company's ROE is similar to the industry average of 11%. Consequently, this likely laid the ground for the impressive net income growth of 38% seen over the past five years by Chemring Group. We reckon that there could also be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
Next, on comparing with the industry net income growth, we found that Chemring Group's growth is quite high when compared to the industry average growth of 12% in the same period, which is great to see.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Chemring Group is trading on a high P/E or a low P/E, relative to its industry.
Is Chemring Group Efficiently Re-investing Its Profits?
Chemring Group's three-year median payout ratio is a pretty moderate 32%, meaning the company retains 68% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Chemring Group is reinvesting its earnings efficiently.
Besides, Chemring Group has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 39% over the next three years. Regardless, the future ROE for Chemring Group is speculated to rise to 14% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.
Conclusion
On the whole, we feel that Chemring Group's performance has been quite good. 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. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.
