Chemring Group PLC's (LON:CHG) Stock's On An Uptrend: Are Strong Financials Guiding The Market?

Chemring Group (LON:CHG) has had a great run on the share market with its stock up by a significant 15% over the last month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Particularly, we will be paying attention to Chemring Group's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Chemring Group

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 Chemring Group is:

10.0% = UK£38m ÷ UK£379m (Based on the trailing twelve months to October 2023).

The 'return' is the profit 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 £0.10 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

A Side By Side comparison of Chemring Group's Earnings Growth And 10.0% ROE

At first glance, Chemring Group seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 10%. This probably goes some way in explaining Chemring Group's significant 38% net income growth over the past five years amongst other factors. We reckon that there could also be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

Next, on comparing with the industry net income growth, we found that Chemring Group's growth is quite high when compared to the industry average growth of 10% in the same period, which is great to see.

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. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Chemring Group is trading on a high P/E or a low P/E, relative to its industry.

Is Chemring Group Efficiently Re-investing Its Profits?

The three-year median payout ratio for Chemring Group is 32%, which is moderately low. The company is retaining the remaining 68%. By the looks of it, the dividend is well covered and Chemring Group is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Additionally, Chemring Group has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 40% over the next three years. Regardless, the future ROE for Chemring Group is speculated to rise to 15% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.

Conclusion

Overall, we are quite pleased with Chemring Group's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.