Do Its Financials Have Any Role To Play In Driving CD Projekt S.A.'s (WSE:CDR) Stock Up Recently?

CD Projekt's (WSE:CDR) stock is up by a considerable 24% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study CD Projekt'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for CD Projekt

How To Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for CD Projekt is:

23% = zł561m ÷ zł2.5b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. So, this means that for every PLN1 of its shareholder's investments, the company generates a profit of PLN0.23.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of CD Projekt's Earnings Growth And 23% ROE

To begin with, CD Projekt seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 14%. However, for some reason, the higher returns aren't reflected in CD Projekt's meagre five year net income growth average of 4.9%. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or poor allocation of capital.

Next, on comparing with the industry net income growth, we found that CD Projekt's reported growth was lower than the industry growth of 16% over the last few years, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. 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?

While CD Projekt has a decent three-year median payout ratio of 31% (or a retention ratio of 69%), it has seen very little growth in earnings. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

In addition, CD Projekt has been paying dividends over a period of seven years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 8.5% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 29%, over the same period.

Conclusion

In total, it does look like CD Projekt has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.