Cargotec's (HEL:CGCBV) stock is up by 8.7% over the past three months. However, in this article, we decided to focus on its weak financials, as long-term fundamentals ultimately dictate market outcomes. Particularly, we will be paying attention to Cargotec's ROE today.
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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
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 Cargotec is:
0.5% = €6.5m ÷ €1.3b (Based on the trailing twelve months to March 2021).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every €1 of its shareholder's investments, the company generates a profit of €0.01.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
Cargotec's Earnings Growth And 0.5% 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. Given the circumstances, the significant decline in net income by 28% seen by Cargotec over the last five years is not surprising. 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.
Next, when we compared with the industry, which has shrunk its earnings at a rate of 0.6% in the same period, we still found Cargotec's performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 CGCBV fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Cargotec Using Its Retained Earnings Effectively?
With a high three-year median payout ratio of 71% (implying that 29% of the profits are retained), most of Cargotec'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. Our risks dashboard should have the 4 risks we have identified for Cargotec.
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. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 29% 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 15%, over the same period.
On the whole, Cargotec's performance is quite a big let-down. 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 latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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