Will Weakness in Karat Packaging Inc.'s (NASDAQ:KRT) Stock Prove Temporary Given Strong Fundamentals?
Karat Packaging (NASDAQ:KRT) has had a rough three months with its share price down 9.0%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Karat Packaging's ROE in this article.
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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
See our latest analysis for Karat Packaging
How Is ROE Calculated?
ROE 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 Karat Packaging is:
20% = US$34m ÷ US$165m (Based on the trailing twelve months to September 2023).
The 'return' is the amount earned after tax 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 $0.20 in profit.
What Has ROE Got To Do With 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.
A Side By Side comparison of Karat Packaging's Earnings Growth And 20% ROE
To begin with, Karat Packaging seems to have a respectable ROE. Even when compared to the industry average of 18% the company's ROE looks quite decent. This certainly adds some context to Karat Packaging's exceptional 45% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.
We then compared Karat Packaging's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 23% in the same 5-year 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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Karat Packaging's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Karat Packaging Using Its Retained Earnings Effectively?
Karat Packaging's ' three-year median payout ratio is on the lower side at 3.5% implying that it is retaining a higher percentage (96%) of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.
Summary
On the whole, we feel that Karat Packaging's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.
