Cairn Homes plc's (LON:CRN) Stock Is Going Strong: Is the Market Following Fundamentals?

Cairn Homes' (LON:CRN) stock is up by a considerable 15% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Specifically, we decided to study Cairn Homes' 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Cairn Homes

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 Cairn Homes is:

11% = €85m ÷ €757m (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.11 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.

Cairn Homes' Earnings Growth And 11% ROE

To begin with, Cairn Homes seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 9.9%. Consequently, this likely laid the ground for the impressive net income growth of 22% seen over the past five years by Cairn Homes. We reckon that there could also be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

When you consider the fact that the industry earnings have shrunk at a rate of 3.6% in the same 5-year period, the company's net income growth is pretty remarkable.

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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Cairn Homes''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Cairn Homes Making Efficient Use Of Its Profits?

Cairn Homes has a significant three-year median payout ratio of 62%, meaning the company only retains 38% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.

Additionally, Cairn Homes has paid dividends over a period of four years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 39% over the next three years. As a result, the expected drop in Cairn Homes' payout ratio explains the anticipated rise in the company's future ROE to 16%, over the same period.

Conclusion

In total, we are pretty happy with Cairn Homes' performance. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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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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.