Cargotec (HEL:CGCBV) has had a great run on the share market with its stock up by a significant 40% over the last three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Specifically, we decided to study Cargotec'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 Do You 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 Cargotec is:
0.6% = €8.2m ÷ €1.3b (Based on the trailing twelve months to December 2020).
The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every €1 worth of equity, the company was able to earn €0.01 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. 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.
Cargotec's Earnings Growth And 0.6% ROE
As you can see, Cargotec's ROE looks pretty weak. Not just that, even compared to the industry average of 12%, the company's ROE is entirely unremarkable. For this reason, Cargotec's five year net income decline of 24% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
So, as a next step, we compared Cargotec'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 2.0% in the same period.
Earnings growth is a huge factor in stock valuation. 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. What is CGCBV worth today? The intrinsic value infographic in our free research report helps visualize whether CGCBV is currently mispriced by the market.
Is Cargotec Using Its Retained Earnings Effectively?
Cargotec's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 68% (or a retention ratio of 32%). With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 5 risks we have identified for Cargotec by visiting our risks dashboard for free on our platform here.
Moreover, Cargotec 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 38% over the next three years. As a result, the expected drop in Cargotec's payout ratio explains the anticipated rise in the company's future ROE to 13%, over the same period.
Overall, we would be extremely cautious before making any decision on Cargotec. As a result of its low ROE and lack of mich reinvestment into the business, the company has seen a disappointing earnings growth rate. 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 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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