Declining Stock and Solid Fundamentals: Is The Market Wrong About CD Projekt S.A. (WSE:CDR)?

CD Projekt (WSE:CDR) has had a rough week with its share price down 19%. 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 CD Projekt's ROE in this article.

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.

See our latest analysis for CD Projekt

How Do You Calculate Return On Equity?

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 CD Projekt is:

15% = zł300m ÷ zł2.0b (Based on the trailing twelve months to September 2022).

The 'return' is the yearly profit. One way to conceptualize this is that for each PLN1 of shareholders' capital it has, the company made PLN0.15 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.

A Side By Side comparison of CD Projekt's Earnings Growth And 15% ROE

To start with, CD Projekt's ROE looks acceptable. Even when compared to the industry average of 17% the company's ROE looks quite decent. This probably goes some way in explaining CD Projekt's significant 29% net income growth over the past five years amongst other factors. However, there could also be other drivers behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

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 30% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if CD Projekt is trading on a high P/E or a low P/E, relative to its industry.

Is CD Projekt Making Efficient Use Of Its Profits?

CD Projekt has a three-year median payout ratio of 45% (where it is retaining 55% of its income) which is not too low or not too high. So it seems that CD Projekt is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Moreover, CD Projekt is determined to keep sharing its profits with shareholders which we infer from its long history of six years of paying a dividend. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 29% over the next three years. Regardless, the future ROE for CD Projekt is predicted to decline to 9.6% despite the anticipated decrease in the payout ratio. We reckon that there could probably be other factors that could be driving the forseen decline in the company's ROE.

Summary

Overall, we are quite pleased with CD Projekt's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. 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.