CTT Systems AB (publ)'s (STO:CTT) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

CTT Systems (STO:CTT) has had a great run on the share market with its stock up by a significant 10% over the last week. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on CTT Systems' ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for CTT Systems

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 CTT Systems is:

12% = kr27m ÷ kr222m (Based on the trailing twelve months to March 2022).

The 'return' is the yearly profit. One way to conceptualize this is that for each SEK1 of shareholders' capital it has, the company made SEK0.12 in profit.

Why Is ROE Important For 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. 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.

CTT Systems' Earnings Growth And 12% ROE

At first glance, CTT Systems seems to have a decent ROE. Especially when compared to the industry average of 6.5% the company's ROE looks pretty impressive. Needless to say, we are quite surprised to see that CTT Systems' net income shrunk at a rate of 13% over the past five years. Therefore, there might be some other aspects that could explain this. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

So, as a next step, we compared CTT Systems' performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 4.5% 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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about CTT Systems''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is CTT Systems Efficiently Re-investing Its Profits?

CTT Systems' declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 70% (or a retention ratio of 30%). With only a little being reinvested into the business, earnings growth would obviously be low or non-existent.

In addition, CTT Systems has been paying dividends over a period of seven years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 70%. Regardless, the future ROE for CTT Systems is predicted to rise to 35% despite there being not much change expected in its payout ratio.

Conclusion

In total, it does look like CTT Systems 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. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.