Declining Stock and Solid Fundamentals: Is The Market Wrong About Capital Limited (LON:CAPD)?
Capital (LON:CAPD) has had a rough month with its share price down 14%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Capital's ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
See our latest analysis for Capital
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 Capital is:
32% = US$70m ÷ US$223m (Based on the trailing twelve months to December 2021).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.32 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 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 Capital's Earnings Growth And 32% ROE
First thing first, we like that Capital has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 6.2% also doesn't go unnoticed by us. As a result, Capital's exceptional 62% net income growth seen over the past five years, doesn't come as a surprise.
Next, on comparing with the industry net income growth, we found that Capital's growth is quite high when compared to the industry average growth of 11% in the same period, which is great to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Has the market priced in the future outlook for CAPD? You can find out in our latest intrinsic value infographic research report.
Is Capital Efficiently Re-investing Its Profits?
Capital's ' three-year median payout ratio is on the lower side at 14% implying that it is retaining a higher percentage (86%) of its profits. So it looks like Capital is reinvesting profits heavily to grow its business, which shows in its earnings growth.
Besides, Capital has been paying dividends over a period of seven years. This shows that the company is committed to sharing profits with its shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 31% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company's expected ROE (to 11%) over the same period.
Summary
In total, we are pretty happy with Capital'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. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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.
