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With its stock down 25% over the past three months, it is easy to disregard Clover (ASX:CLV). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Clover's ROE.
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. Put another way, it reveals the company's success at turning shareholder investments into profits.
How Is ROE Calculated?
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 Clover is:
22% = AU$12m ÷ AU$58m (Based on the trailing twelve months to July 2020).
The 'return' is the yearly profit. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.22 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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 Clover's Earnings Growth And 22% ROE
To begin with, Clover seems to have a respectable ROE. On comparing with the average industry ROE of 7.8% the company's ROE looks pretty remarkable. This certainly adds some context to Clover's exceptional 45% net income growth seen over the past five years. We reckon that there could also be other factors at play here. Such as - high earnings retention or an efficient management in place.
Next, on comparing Clover's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 50% in the same period.
Earnings growth is a huge factor in stock valuation. 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. Is Clover fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Clover Efficiently Re-investing Its Profits?
Clover's three-year median payout ratio is a pretty moderate 36%, meaning the company retains 64% of its income. By the looks of it, the dividend is well covered and Clover is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.
Moreover, Clover 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 42% of its profits over the next three years. Accordingly, forecasts suggest that Clover's future ROE will be 21% which is again, similar to the current ROE.
Overall, we are quite pleased with Clover's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.
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