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

With its stock down 37% over the past three months, it is easy to disregard Codan (ASX:CDA). 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 Codan's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Codan

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 Codan is:

30% = AU$90m ÷ AU$304m (Based on the trailing twelve months to June 2021).

The 'return' is the yearly profit. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.30.

What Is The Relationship Between ROE And 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.

Codan's Earnings Growth And 30% ROE

First thing first, we like that Codan has an impressive ROE. Further, even comparing with the industry average if 30%, the company's ROE is quite respectable. Given the circumstances, the significant 23% net income growth seen by Codan over the last five years is not surprising.

Next, on comparing with the industry net income growth, we found that Codan's growth is quite high when compared to the industry average growth of 13% in the same period, which is great to see.

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 CDA worth today? The intrinsic value infographic in our free research report helps visualize whether CDA is currently mispriced by the market.

Is Codan Using Its Retained Earnings Effectively?

Codan's three-year median payout ratio is a pretty moderate 42%, meaning the company retains 58% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Codan is reinvesting its earnings efficiently.

Moreover, Codan is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 48%. As a result, Codan's ROE is not expected to change by much either, which we inferred from the analyst estimate of 28% for future ROE.

Summary

Overall, we are quite pleased with Codan'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. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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.

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