James Cropper's's (LON:CRPR) stock is up by a considerable 61% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to James Cropper's ROE today.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company's success at turning shareholder investments into profits.
How Do You Calculate Return On Equity?
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 James Cropper is:
14% = UK£4.8m ÷ UK£34m (Based on the trailing twelve months to March 2020).
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 £0.14 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learnt that ROE is a measure of a company's profitability. 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 James Cropper's Earnings Growth And 14% ROE
To start with, James Cropper's ROE looks acceptable. Especially when compared to the industry average of 9.5% the company's ROE looks pretty impressive. This certainly adds some context to James Cropper's decent 5.7% net income growth seen over the past five years.
As a next step, we compared James Cropper'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 12% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is James Cropper fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is James Cropper Efficiently Re-investing Its Profits?
With a three-year median payout ratio of 31% (implying that the company retains 69% of its profits), it seems that James Cropper is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.
In total, we are pretty happy with James Cropper's performance. 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 a good amount of 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. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. You can see the 2 risks we have identified for James Cropper by visiting our risks dashboard for free on our platform here.
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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