Credit Intelligence's's (ASX:CI1) stock is up by a considerable 32% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to Credit Intelligence's ROE today.
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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
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 Credit Intelligence is:
20% = AU$1.9m ÷ AU$9.3m (Based on the trailing twelve months to December 2019).
The 'return' is the amount earned after tax over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.20 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learnt 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. 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.
Credit Intelligence's Earnings Growth And 20% ROE
To start with, Credit Intelligence's ROE looks acceptable. Especially when compared to the industry average of 12% the company's ROE looks pretty impressive. Needless to say, we are quite surprised to see that Credit Intelligence's net income shrunk at a rate of 42% over the past five years. We reckon that there could be some other factors at play here that are preventing the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
However, when we compared Credit Intelligence's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 17% in the same period. This is quite worrisome.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is Credit Intelligence fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Credit Intelligence Using Its Retained Earnings Effectively?
In spite of a normal LTM (or last twelve month) payout ratio of 28% (that is, a retention ratio of 72%), the fact that Credit Intelligence's earnings have shrunk is quite puzzling. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
Additionally, Credit Intelligence started paying a dividend only recently. So it looks like the management may have perceived that shareholders favor dividends even though earnings have been in decline.
In total, it does look like Credit Intelligence has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. 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. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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