Colas SA's (EPA:RE) Stock's Been Going Strong: Could Weak Financials Mean The Market Will Coorect Its Share Price?

Colas (EPA:RE) has had a great run on the share market with its stock up by a significant 18% 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 Colas' ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Colas

How To Calculate Return On Equity?

The formula for ROE is:

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

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

2.8% = €70m ÷ €2.5b (Based on the trailing twelve months to June 2020).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every €1 worth of equity, the company was able to earn €0.03 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. 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 Colas' Earnings Growth And 2.8% ROE

At first glance, Colas' ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 6.4%. Given the circumstances, the significant decline in net income by 5.7% seen by Colas 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. Such as - low earnings retention or poor allocation of capital.

So, as a next step, we compared Colas' 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 6.2% 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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Colas''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Colas Making Efficient Use Of Its Profits?

Colas' 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 80% (or a retention ratio of 20%). With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. You can see the 4 risks we have identified for Colas by visiting our risks dashboard for free on our platform here.

Moreover, Colas 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.

Summary

On the whole, Colas' 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. Up till now, we've only made a short study of the company's growth data. To gain further insights into Colas' past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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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