Clover Corporation Limited's (ASX:CLV) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

Clover (ASX:CLV) has had a rough three months with its share price down 35%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Clover's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Clover

How Do You Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Clover is:

22% = AU$12m ÷ AU$58m (Based on the trailing twelve months to July 2020).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.22 in profit.

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 Clover's Earnings Growth And 22% ROE

To start with, Clover's ROE looks acceptable. Especially when compared to the industry average of 7.8% the company's ROE looks pretty impressive. Probably as a result of this, Clover was able to see an impressive net income growth of 45% over the last five years. However, there could also be other causes behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing Clover's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 50% in the same period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Clover fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Clover Efficiently Re-investing Its Profits?

The three-year median payout ratio for Clover is 36%, which is moderately low. The company is retaining the remaining 64%. 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.

Besides, Clover has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 42%. Accordingly, forecasts suggest that Clover's future ROE will be 21% which is again, similar to the current ROE.

Summary

In total, we are pretty happy with Clover's performance. 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. 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. 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. 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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