Is Collins Foods Limited's (ASX:CKF) Recent Price Movement Underpinned By Its Weak Fundamentals?

It is hard to get excited after looking at Collins Foods' (ASX:CKF) recent performance, when its stock has declined 3.4% over the past three months. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Specifically, we decided to study Collins Foods' ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Collins Foods

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 Collins Foods is:

7.6% = AU$27m ÷ AU$361m (Based on the trailing twelve months to October 2020).

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$0.08.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Collins Foods' Earnings Growth And 7.6% ROE

When you first look at it, Collins Foods' ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 8.1%. We can see that Collins Foods has grown at a five year net income growth average rate of 4.7%, which is a bit on the lower side. Bear in mind, the company's ROE is not very high . So this could also be one of the reasons behind the company's low growth in earnings.

Next, on comparing Collins Foods' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 4.7% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is CKF fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Collins Foods Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 61% (that is, the company retains only 39% of its income) over the past three years for Collins Foods suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.

Additionally, Collins Foods has paid dividends over a period of nine years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 62% of its profits over the next three years. Still, forecasts suggest that Collins Foods' future ROE will rise to 15% even though the the company's payout ratio is not expected to change by much.

Summary

On the whole, we feel that the performance shown by Collins Foods can be open to many interpretations. Although the company has shown a fair bit of growth in earnings, the reinvestment rate is low. Meaning, the earnings growth number could have been significantly higher had the company been retaining more of its profits and reinvesting that at a higher rate of return. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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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