Are Strong Financial Prospects The Force That Is Driving The Momentum In Circa Enterprises Inc.'s CVE:CTO) Stock?

Most readers would already be aware that Circa Enterprises' (CVE:CTO) stock increased significantly by 16% over the past month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Circa Enterprises' ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Circa Enterprises

How To Calculate Return On Equity?

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 Circa Enterprises is:

15% = CA$1.9m ÷ CA$13m (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. That means that for every CA$1 worth of shareholders' equity, the company generated CA$0.15 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

A Side By Side comparison of Circa Enterprises' Earnings Growth And 15% ROE

To start with, Circa Enterprises' ROE looks acceptable. Especially when compared to the industry average of 7.5% the company's ROE looks pretty impressive. This certainly adds some context to Circa Enterprises' decent 18% net income growth seen over the past five years.

As a next step, we compared Circa Enterprises' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 18% 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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Circa Enterprises is trading on a high P/E or a low P/E, relative to its industry.

Is Circa Enterprises Using Its Retained Earnings Effectively?

Conclusion

Overall, we are quite pleased with Circa Enterprises' 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. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. You can see the 4 risks we have identified for Circa Enterprises by visiting our risks dashboard for free on our platform here.

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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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