Most readers would already be aware that Cencosud's (SNSE:CENCOSUD) stock increased significantly by 14% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study Cencosud's ROE in this article.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Is ROE Calculated?
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 Cencosud is:
1.4% = CL$65b ÷ CL$4.5t (Based on the trailing twelve months to December 2020).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every CLP1 worth of equity, the company was able to earn CLP0.01 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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.
Cencosud's Earnings Growth And 1.4% ROE
It is hard to argue that Cencosud's ROE is much good in and of itself. Not just that, even compared to the industry average of 8.3%, the company's ROE is entirely unremarkable. Therefore, it might not be wrong to say that the five year net income decline of 28% seen by Cencosud was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.
So, as a next step, we compared Cencosud's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 7.0% in the same period.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is Cencosud fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Cencosud Efficiently Re-investing Its Profits?
Cencosud's low three-year median payout ratio of 13% (implying that it retains the remaining 87% of its profits) comes as a surprise when you pair it with the shrinking earnings. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
Moreover, Cencosud 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. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 37% over the next three years. Regardless, the future ROE for Cencosud is speculated to rise to 7.3% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.
In total, we're a bit ambivalent about Cencosud's performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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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