Does CAP S.A.'s (SNSE:CAP) Weak Fundamentals Mean That The Market Could Correct Its Share Price?

Most readers would already be aware that CAP's (SNSE:CAP) stock increased significantly by 49% over the past three months. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. Specifically, we decided to study CAP'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 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 CAP

How Is ROE Calculated?

The formula for ROE is:

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

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

4.2% = US$139m ÷ US$3.3b (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. That means that for every CLP1 worth of shareholders' equity, the company generated CLP0.04 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

CAP's Earnings Growth And 4.2% ROE

It is quite clear that CAP's ROE is rather low. Not just that, even compared to the industry average of 6.4%, the company's ROE is entirely unremarkable. Given the circumstances, the significant decline in net income by 8.3% seen by CAP over the last five years is not surprising. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.

However, when we compared CAP's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 16% in the same period. This is quite worrisome.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is CAP fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is CAP Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 53% (implying that 47% of the profits are retained), most of CAP's profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent.

Moreover, CAP has been paying dividends for nine years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 97% over the next three years. However, CAP's future ROE is expected to rise to 8.7% despite the expected increase in the company's payout ratio. We infer that there could be other factors that could be driving the anticipated growth in the company's ROE.

Summary

In total, we would have a hard think before deciding on any investment action concerning CAP. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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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