Weak Financial Prospects Seem To Be Dragging Down Cleanaway Waste Management Limited (ASX:CWY) Stock
It is hard to get excited after looking at Cleanaway Waste Management's (ASX:CWY) recent performance, when its stock has declined 8.6% over the past month. To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. Specifically, we decided to study Cleanaway Waste Management's ROE in this article.
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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
View our latest analysis for Cleanaway Waste Management
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 Cleanaway Waste Management is:
0.8% = AU$24m ÷ AU$2.9b (Based on the trailing twelve months to June 2023).
The 'return' is the income the business earned over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.01.
What Is The Relationship Between ROE And Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Cleanaway Waste Management's Earnings Growth And 0.8% ROE
It is hard to argue that Cleanaway Waste Management's ROE is much good in and of itself. Not just that, even compared to the industry average of 8.6%, the company's ROE is entirely unremarkable. Therefore, it might not be wrong to say that the five year net income decline of 11% seen by Cleanaway Waste Management was possibly a result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
That being said, we compared Cleanaway Waste Management's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 4.2% in the same 5-year 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. This then helps them determine if the stock is placed for a bright or bleak future. Is CWY fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Cleanaway Waste Management Making Efficient Use Of Its Profits?
Cleanaway Waste Management has a high three-year median payout ratio of 84% (that is, it is retaining 16% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only very little left to reinvest into the business, growth in earnings is far from likely. Our risks dashboard should have the 2 risks we have identified for Cleanaway Waste Management.
Additionally, Cleanaway Waste Management has paid dividends over a period of nine years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 65% over the next three years. As a result, the expected drop in Cleanaway Waste Management's payout ratio explains the anticipated rise in the company's future ROE to 8.4%, over the same period.
Conclusion
In total, we would have a hard think before deciding on any investment action concerning Cleanaway Waste Management. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.
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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.
