Are Strong Financial Prospects The Force That Is Driving The Momentum In Packaging Corporation of America's NYSE:PKG) Stock?
Packaging Corporation of America's (NYSE:PKG) stock is up by a considerable 22% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Particularly, we will be paying attention to Packaging Corporation of America's ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
See our latest analysis for Packaging Corporation of America
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 Packaging Corporation of America is:
15% = US$474m ÷ US$3.2b (Based on the trailing twelve months to September 2020).
The 'return' is the profit over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.15 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.
Packaging Corporation of America's Earnings Growth And 15% ROE
To begin with, Packaging Corporation of America seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 16%. This certainly adds some context to Packaging Corporation of America's moderate 9.5% net income growth seen over the past five years.
We then performed a comparison between Packaging Corporation of America's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 9.5% in the same period.
Earnings growth is a huge factor in stock valuation. 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. What is PKG worth today? The intrinsic value infographic in our free research report helps visualize whether PKG is currently mispriced by the market.
Is Packaging Corporation of America Using Its Retained Earnings Effectively?
Packaging Corporation of America has a three-year median payout ratio of 38%, which implies that it retains the remaining 62% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.
Moreover, Packaging Corporation of America is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 47% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.
Conclusion
On the whole, we feel that Packaging Corporation of America's performance has been quite good. 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, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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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