Is ConvaTec Group PLC's (LON:CTEC) Recent Performance Underpinned By Weak Financials?

With its stock down 3.3% over the past three months, it is easy to disregard ConvaTec Group (LON:CTEC). To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. Specifically, we decided to study ConvaTec Group's ROE in this article.

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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for ConvaTec Group

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 ConvaTec Group is:

3.9% = US$63m ÷ US$1.6b (Based on the trailing twelve months to December 2022).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.04 in profit.

Why Is ROE Important For Earnings Growth?

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

ConvaTec Group's Earnings Growth And 3.9% ROE

At first glance, ConvaTec Group's ROE doesn't look very promising. However, its ROE is similar to the industry average of 4.2%, so we won't completely dismiss the company. But then again, ConvaTec Group's five year net income shrunk at a rate of 21%. Bear in mind, the company does have a slightly low ROE. So that's what might be causing earnings growth to shrink.

As a next step, we compared ConvaTec Group's performance with the industry and found thatConvaTec Group's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 13% in the same period, which is a slower than the company.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is CTEC fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is ConvaTec Group Using Its Retained Earnings Effectively?

ConvaTec Group's high three-year median payout ratio of 148% suggests that the company is depleting its resources to keep up its dividend payments, and this shows in its shrinking earnings. Paying a dividend beyond their means is usually not viable over the long term. You can see the 4 risks we have identified for ConvaTec Group by visiting our risks dashboard for free on our platform here.

Additionally, ConvaTec Group has paid dividends over a period of six years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 42% over the next three years. As a result, the expected drop in ConvaTec Group's payout ratio explains the anticipated rise in the company's future ROE to 19%, over the same period.

Summary

On the whole, ConvaTec Group's performance is quite a big let-down. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.