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Is Constellation Software Inc.'s (TSE:CSU) Recent Performance Tethered To Its Attractive Financial Prospects?

Simply Wall St
·4 min read

Constellation Software's (TSE:CSU) stock is up by 8.2% over the past three months. Given its impressive performance, we decided to study the company's key financial indicators as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Constellation Software's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Constellation Software

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 Constellation Software is:

42% = US$380m ÷ US$902m (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each CA$1 of shareholders' capital it has, the company made CA$0.42 in profit.

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 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.

A Side By Side comparison of Constellation Software's Earnings Growth And 42% ROE

To begin with, Constellation Software has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 20% the company's ROE is quite impressive. This probably laid the groundwork for Constellation Software's moderate 18% net income growth seen over the past five years.

We then performed a comparison between Constellation Software's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 16% in the same period.

past-earnings-growth
past-earnings-growth

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. What is CSU worth today? The intrinsic value infographic in our free research report helps visualize whether CSU is currently mispriced by the market.

Is Constellation Software Using Its Retained Earnings Effectively?

Constellation Software has a three-year median payout ratio of 26%, which implies that it retains the remaining 74% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Moreover, Constellation Software is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 8.4% over the next three years.

Summary

In total, we are pretty happy with Constellation Software's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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. 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.

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