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Collins Foods Limited's (ASX:CKF) Recent Stock Performance Looks Decent- Can Strong Fundamentals Be the Reason?

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Collins Foods' (ASX:CKF) stock is up by 4.5% over the past month. Since the market usually pay for a company’s long-term financial health, we decided to study the company’s fundamentals to see if they could be influencing the market. Specifically, we decided to study Collins Foods' ROE in this article.

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.

Check out our latest analysis for Collins Foods

How Is ROE Calculated?

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 Collins Foods is:

14% = AU$55m ÷ AU$394m (Based on the trailing twelve months to May 2022).

The 'return' refers to a company's earnings over the last year. That means that for every A$1 worth of shareholders' equity, the company generated A$0.14 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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.

A Side By Side comparison of Collins Foods' Earnings Growth And 14% ROE

At first glance, Collins Foods seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 12%. This certainly adds some context to Collins Foods' moderate 8.9% net income growth seen over the past five years.

As a next step, we compared Collins Foods' 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 8.1% in the same period.

past-earnings-growth
past-earnings-growth

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Is CKF fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Collins Foods Making Efficient Use Of Its Profits?

While Collins Foods has a three-year median payout ratio of 68% (which means it retains 32% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.

Additionally, Collins Foods has paid dividends over a period of at least ten 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 over the next three years is expected to be approximately 54%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 16%.

Summary

In total, we are pretty happy with Collins Foods' performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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