Compass Group PLC's (LON:CPG) Stock Been Rising: Are Strong Financials Guiding The Market?

Compass Group's (LON:CPG) stock is up by 7.2% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Compass Group's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Compass Group

How To 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 Compass Group is:

20% = US$1.4b ÷ US$6.9b (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. That means that for every £1 worth of shareholders' equity, the company generated £0.20 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Compass Group's Earnings Growth And 20% ROE

At first glance, Compass Group seems to have a decent ROE. Especially when compared to the industry average of 7.9% the company's ROE looks pretty impressive. This probably laid the ground for Compass Group's significant 20% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then performed a comparison between Compass Group's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 25% in the same 5-year period.

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. Is Compass Group fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Compass Group Efficiently Re-investing Its Profits?

Compass Group has a significant three-year median payout ratio of 57%, meaning the company only retains 43% 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, Compass 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 50%. Regardless, the future ROE for Compass Group is predicted to rise to 29% despite there being not much change expected in its payout ratio.

Conclusion

In total, we are pretty happy with Compass Group's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. 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 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.