Is CMC Corporation's (TYO:2185) Latest Stock Performance A Reflection Of Its Financial Health?

CMC (TYO:2185) has had a great run on the share market with its stock up by a significant 24% over the last 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 CMC's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for CMC

How Is ROE Calculated?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for CMC is:

8.7% = JP¥1.3b ÷ JP¥15b (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. That means that for every ¥1 worth of shareholders' equity, the company generated ¥0.09 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

CMC's Earnings Growth And 8.7% ROE

To begin with, CMC seems to have a respectable ROE. Especially when compared to the industry average of 7.2% the company's ROE looks pretty impressive. This probably laid the ground for CMC's moderate 9.3% net income growth seen over the past five years.

As a next step, we compared CMC's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 5.8%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about CMC's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is CMC Making Efficient Use Of Its Profits?

CMC's three-year median payout ratio to shareholders is 21% (implying that it retains 79% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Moreover, CMC is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Conclusion

In total, we are pretty happy with CMC's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. To know the 1 risk we have identified for CMC visit our risks dashboard for free.

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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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