Should Weakness in Packaging Corporation of America's (NYSE:PKG) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?
Packaging Corporation of America (NYSE:PKG) has had a rough month with its share price down 7.7%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Packaging Corporation of America's ROE.
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 Packaging Corporation of America
How Do You Calculate Return On Equity?
The formula for ROE 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$486m ÷ US$3.3b (Based on the trailing twelve months to March 2021).
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 $0.15 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
Packaging Corporation of America's Earnings Growth And 15% ROE
At first glance, Packaging Corporation of America seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 15%. Despite the moderate return on equity, Packaging Corporation of America has posted a net income growth of 4.3% over the past five years. A few likely reasons that could be keeping earnings growth low are - the company has a high payout ratio or the business has allocated capital poorly, for instance.
Next, on comparing with the industry net income growth, we found that Packaging Corporation of America's reported growth was lower than the industry growth of 12% in the same period, which is not something we like to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Has the market priced in the future outlook for PKG? You can find out in our latest intrinsic value infographic research report.
Is Packaging Corporation of America Using Its Retained Earnings Effectively?
While Packaging Corporation of America has a decent three-year median payout ratio of 39% (or a retention ratio of 61%), it has seen very little growth in earnings. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.
Additionally, Packaging Corporation of America has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 51% over the next three years. Still, forecasts suggest that Packaging Corporation of America's future ROE will rise to 20% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.
Summary
Overall, we feel that Packaging Corporation of America certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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