Is Cleanaway Waste Management Limited's (ASX:CWY) Recent Performance Underpinned By Weak Financials?

Cleanaway Waste Management (ASX:CWY) has had a rough three months with its share price down 2.3%. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. In this article, we decided to focus on Cleanaway Waste Management's ROE.

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.

How To Calculate Return On Equity?

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 Cleanaway Waste Management is:

5.2% = AU$158m ÷ AU$3.0b (Based on the trailing twelve months to December 2024).

The 'return' is the profit over the last twelve months. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.05.

View our latest analysis for Cleanaway Waste Management

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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 Cleanaway Waste Management's Earnings Growth And 5.2% ROE

At first glance, Cleanaway Waste Management's ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 13% either. Given the circumstances, the significant decline in net income by 4.5% seen by Cleanaway Waste Management over the last five years is not surprising. We reckon that there could also be other factors at play here. 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 15% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is CWY worth today? The intrinsic value infographic in our free research report helps visualize whether CWY is currently mispriced by the market.

Is Cleanaway Waste Management Using Its Retained Earnings Effectively?

Cleanaway Waste Management's high three-year median payout ratio of 129% suggests that the company is depleting its resources to keep up its dividend payments, and this shows in its shrinking earnings. Its usually very hard to sustain dividend payments that are higher than reported profits.

Moreover, Cleanaway Waste Management has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 63% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 9.1%, over the same period.

Summary

Overall, we would be extremely cautious before making any decision on Cleanaway Waste Management. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. 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. 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. 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.