Kansas City Southern's (NYSE:KSU) stock up by 2.0% over the past week. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Kansas City Southern's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Do You 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 Kansas City Southern is:
12% = US$581m ÷ US$4.8b (Based on the trailing twelve months to September 2020).
The 'return' is the profit over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.12.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.
Kansas City Southern's Earnings Growth And 12% ROE
To start with, Kansas City Southern's ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 13%. Despite the modest returns, Kansas City Southern's five year net income growth was quite low, averaging at only 4.4%. A few likely reasons that could be keeping earnings growth low are - the company has a high payout ratio or the business has allocated capital poorly, for instance.
As a next step, we compared Kansas City Southern's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 9.2% in the same period.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is Kansas City Southern fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Kansas City Southern Using Its Retained Earnings Effectively?
Despite having a normal three-year median payout ratio of 25% (or a retention ratio of 75% over the past three years, Kansas City Southern has seen very little growth in earnings as we saw above. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
Moreover, Kansas City Southern has been paying dividends for nine years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 21%. Regardless, the future ROE for Kansas City Southern is predicted to rise to 17% despite there being not much change expected in its payout ratio.
On the whole, we do feel that Kansas City Southern has some positive attributes. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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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