Comvita's (NZSE:CVT) stock is up by 3.8% over the past three months. However, we decided to study the company's mixed-bag of fundamentals to assess what this could mean for future share prices, as stock prices tend to be aligned with a company's long-term financial performance. Particularly, we will be paying attention to Comvita's 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. 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 Comvita is:
5.6% = NZ$13m ÷ NZ$228m (Based on the trailing twelve months to June 2022).
The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every NZ$1 worth of equity, the company was able to earn NZ$0.06 in profit.
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. 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.
Comvita's Earnings Growth And 5.6% ROE
On the face of it, Comvita's ROE is not much to talk about. However, its ROE is similar to the industry average of 5.6%, so we won't completely dismiss the company. Having said that, Comvita's net income growth over the past five years is more or less flat. Bear in mind, the company's ROE is not very high. So that could also be one of the reasons behind the company's flat growth in earnings.
Next, on comparing with the industry net income growth, we found that the industry grew its earnings by7.5% in the same period.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Comvita fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Comvita Using Its Retained Earnings Effectively?
Despite having a moderate three-year median payout ratio of 39% (meaning the company retains61% of profits) in the last three-year period, Comvita's earnings growth was more or les flat. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.
In addition, Comvita has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 44% of its profits over the next three years. Still, forecasts suggest that Comvita's future ROE will rise to 8.6% even though the the company's payout ratio is not expected to change by much.
On the whole, we feel that the performance shown by Comvita can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. 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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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.
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