Are Continental Aktiengesellschaft's (ETR:CON) Mixed Financials The Reason For Its Gloomy Performance on The Stock Market?
Continental (ETR:CON) has had a rough month with its share price down 7.0%. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. In this article, we decided to focus on Continental's ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
View our latest analysis for Continental
How To Calculate Return On Equity?
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 Continental is:
5.2% = €719m ÷ €14b (Based on the trailing twelve months to June 2023).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every €1 of its shareholder's investments, the company generates a profit of €0.05.
Why Is ROE Important For 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Continental's Earnings Growth And 5.2% ROE
When you first look at it, Continental's ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 15% either. Given the circumstances, the significant decline in net income by 29% seen by Continental over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate of 2.8% over the last few years, we found that Continental's performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Continental's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Continental Using Its Retained Earnings Effectively?
Looking at its three-year median payout ratio of 41% (or a retention ratio of 59%) which is pretty normal, Continental's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.
In addition, Continental 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's future payout ratio is expected to drop to 28% over the next three years. As a result, the expected drop in Continental's payout ratio explains the anticipated rise in the company's future ROE to 16%, over the same period.
Summary
Overall, we have mixed feelings about Continental. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.
