Creightons (LON:CRL) has had a rough three months with its share price down 19%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Creightons' ROE today.
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.
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 Creightons is:
16% = UK£3.9m ÷ UK£25m (Based on the trailing twelve months to September 2021).
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 £0.16 in profit.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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 Creightons' Earnings Growth And 16% ROE
To start with, Creightons' ROE looks acceptable. On comparing with the average industry ROE of 9.3% the company's ROE looks pretty remarkable. This certainly adds some context to Creightons' exceptional 30% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
When you consider the fact that the industry earnings have shrunk at a rate of 1.2% in the same period, the company's net income growth is pretty remarkable.
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. If you're wondering about Creightons''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Creightons Making Efficient Use Of Its Profits?
Creightons has a really low three-year median payout ratio of 11%, meaning that it has the remaining 89% left over to reinvest into its business. So it looks like Creightons is reinvesting profits heavily to grow its business, which shows in its earnings growth.
Moreover, Creightons is determined to keep sharing its profits with shareholders which we infer from its long history of five years of paying a dividend.
On the whole, we feel that Creightons' performance has been quite good. 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. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. To know the 3 risks we have identified for Creightons visit our risks dashboard for free.
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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.