ConvaTec Group PLC (LON:CTEC) Stock's On A Decline: Are Poor Fundamentals The Cause?
It is hard to get excited after looking at ConvaTec Group's (LON:CTEC) recent performance, when its stock has declined 6.3% over the past three months. To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. In this article, we decided to focus on ConvaTec Group's ROE.
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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
Check out our latest analysis for ConvaTec Group
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 ConvaTec Group is:
3.9% = US$63m ÷ US$1.6b (Based on the trailing twelve months to December 2022).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.04 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.
ConvaTec Group's Earnings Growth And 3.9% ROE
At first glance, ConvaTec Group's ROE doesn't look very promising. Next, when compared to the average industry ROE of 6.1%, the company's ROE leaves us feeling even less enthusiastic. For this reason, ConvaTec Group's five year net income decline of 21% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.
Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate 13% in the same period, we found that ConvaTec Group's performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.
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. What is CTEC worth today? The intrinsic value infographic in our free research report helps visualize whether CTEC is currently mispriced by the market.
Is ConvaTec Group Making Efficient Use Of Its Profits?
With a three-year median payout ratio as high as 148%,ConvaTec Group's shrinking earnings don't come as a surprise as the company is paying a dividend which is beyond its means. Paying a dividend higher than reported profits is not a sustainable move. You can see the 4 risks we have identified for ConvaTec Group by visiting our risks dashboard for free on our platform here.
In addition, ConvaTec Group has been paying dividends over a period of six years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 42% over the next three years. The fact that the company's ROE is expected to rise to 19% over the same period is explained by the drop in the payout ratio.
Summary
In total, we would have a hard think before deciding on any investment action concerning ConvaTec Group. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings 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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