CD Projekt S.A.'s (WSE:CDR) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

With its stock down 32% over the past three months, it is easy to disregard CD Projekt (WSE:CDR). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on CD Projekt'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.

View our latest analysis for CD Projekt

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 CD Projekt is:

11% = zł209m ÷ zł1.9b (Based on the trailing twelve months to December 2021).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every PLN1 of its shareholder's investments, the company generates a profit of PLN0.11.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

A Side By Side comparison of CD Projekt's Earnings Growth And 11% ROE

At first glance, CD Projekt seems to have a decent ROE. Even so, when compared with the average industry ROE of 20%, we aren't very excited. That being the case, the significant five-year 39% net income growth reported by CD Projekt comes as a pleasant surprise. Therefore, there could be other causes behind this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this certainly also provides some context to the high earnings growth seen by the company.

We then performed a comparison between CD Projekt's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 43% in the same period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 CD Projekt's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is CD Projekt Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 69% (implying that it keeps only 31% of profits) for CD Projekt suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.

Moreover, CD Projekt is determined to keep sharing its profits with shareholders which we infer from its long history of five years of paying a dividend. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 45% over the next three years. The fact that the company's ROE is expected to rise to 13% over the same period is explained by the drop in the payout ratio.

Conclusion

Overall, we feel that CD Projekt certainly does have some positive factors to consider. Namely, its significant earnings growth, to which its moderate rate of return likely contributed. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.