Declining Stock and Solid Fundamentals: Is The Market Wrong About Cerillion Plc (LON:CER)?

With its stock down 7.7% over the past month, it is easy to disregard Cerillion (LON:CER). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Cerillion's 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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Cerillion

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 Cerillion is:

16% = UK£2.6m ÷ UK£16m (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. That means that for every £1 worth of shareholders' equity, the company generated £0.16 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. 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.

Cerillion's Earnings Growth And 16% ROE

To start with, Cerillion's ROE looks acceptable. Especially when compared to the industry average of 8.3% the company's ROE looks pretty impressive. This probably laid the ground for Cerillion's moderate 19% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that Cerillion'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 a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Cerillion fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Cerillion Using Its Retained Earnings Effectively?

While Cerillion has a three-year median payout ratio of 67% (which means it retains 33% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.

Besides, Cerillion has been paying dividends over a period of five years. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 49% over the next three years.

Summary

In total, we are pretty happy with Cerillion'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. Up till now, we've only made a short study of the company's growth data. To gain further insights into Cerillion's 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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