Is Weakness In Commercial Metals Company (NYSE:CMC) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

With its stock down 9.0% over the past three months, it is easy to disregard Commercial Metals (NYSE:CMC). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Commercial Metals' 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.

Check out our latest analysis for Commercial Metals

How Is ROE Calculated?

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 Commercial Metals is:

16% = US$680m ÷ US$4.2b (Based on the trailing twelve months to February 2024).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.16 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 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.

Commercial Metals' Earnings Growth And 16% ROE

To start with, Commercial Metals' ROE looks acceptable. On comparing with the average industry ROE of 9.8% the company's ROE looks pretty remarkable. This certainly adds some context to Commercial Metals' exceptional 34% net income growth seen over the past five years. However, there could also be other causes behind this growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Commercial Metals' growth is quite high when compared to the industry average growth of 25% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is CMC fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Commercial Metals Making Efficient Use Of Its Profits?

Commercial Metals has a really low three-year median payout ratio of 8.7%, meaning that it has the remaining 91% left over to reinvest into its business. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Besides, Commercial Metals has been paying dividends for at least ten years or more. 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's future payout ratio is expected to rise to 15% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company's expected ROE (to 11%) over the same period.

Summary

Overall, we are quite pleased with Commercial Metals' 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. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com