Cloetta (STO:CLA B) has had a rough week with its share price down 15%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Cloetta's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
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 Cloetta is:
11% = kr500m ÷ kr4.7b (Based on the trailing twelve months to March 2022).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each SEK1 of shareholders' capital it has, the company made SEK0.11 in profit.
What Is The Relationship Between ROE And 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 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.
Cloetta's Earnings Growth And 11% ROE
To start with, Cloetta's ROE looks acceptable. On comparing with the average industry ROE of 7.0% the company's ROE looks pretty remarkable. Probably as a result of this, Cloetta was able to see a decent growth of 5.1% over the last five years.
Next, on comparing with the industry net income growth, we found that Cloetta's reported growth was lower than the industry growth of 8.7% in the same period, which is not something we like to see.
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. If you're wondering about Cloetta's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Cloetta Using Its Retained Earnings Effectively?
The high three-year median payout ratio of 59% (or a retention ratio of 41%) for Cloetta suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.
Besides, Cloetta has been paying dividends over a period of six years. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 63% of its profits over the next three years. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 12%.
In total, it does look like Cloetta has some positive aspects to its business. Its earnings have grown respectably as we saw earlier, which was likely due to the company reinvesting its earnings at a pretty high rate of return. However, given the high ROE, we do think that the company is reinvesting a small portion of its profits. This could likely be preventing the company from growing to its full extent. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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.