Clover Corporation Limited's (ASX:CLV) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

Clover (ASX:CLV) has had a rough three months with its share price down 8.1%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Clover's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Clover

How Is ROE Calculated?

Return on equity 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 Clover is:

21% = AU$10m ÷ AU$49m (Based on the trailing twelve months to January 2020).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.21 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. 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.

Clover's Earnings Growth And 21% ROE

At first glance, Clover seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 15%. This certainly adds some context to Clover's exceptional 52% 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. Such as - high earnings retention or an efficient management in place.

We then performed a comparison between Clover's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 47% in the same 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. Doing so will help them establish if the stock's future looks promising or ominous. Is Clover fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Clover Using Its Retained Earnings Effectively?

The three-year median payout ratio for Clover is 37%, which is moderately low. The company is retaining the remaining 63%. So it seems that Clover is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Looking at the current analyst consensus data, we can see 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.

Summary

In total, we are pretty happy with Clover'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 substantial growth in its earnings. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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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