Is Packaging Corporation of America's Stock Rally Tied To Its Strong Fundamentals?

Packaging Corporation of America's (NYSE:PKG) stock is up by a considerable 11% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Packaging Corporation of America's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Packaging Corporation of America

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Packaging Corporation of America is:

26% = US$1.0b ÷ US$4.0b (Based on the trailing twelve months to September 2022).

The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.26.

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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Packaging Corporation of America's Earnings Growth And 26% ROE

To begin with, Packaging Corporation of America has a pretty high ROE which is interesting. Additionally, a comparison with the average industry ROE of 22% also portrays the company's ROE in a good light. Therefore, it looks like the high ROE is what probably supported Packaging Corporation of America's modest 5.3% growth over the past five years.

As a next step, we compared Packaging Corporation of America's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 8.1% in the same period.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. What is PKG worth today? The intrinsic value infographic in our free research report helps visualize whether PKG is currently mispriced by the market.

Is Packaging Corporation of America Efficiently Re-investing Its Profits?

Packaging Corporation of America has a healthy combination of a moderate three-year median payout ratio of 46% (or a retention ratio of 54%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Besides, Packaging Corporation of America has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 50%. However, Packaging Corporation of America's future ROE is expected to decline to 20% despite there being not much change anticipated in the company's payout ratio.

Summary

In total, we are pretty happy with Packaging Corporation of America's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see a good amount of growth in its earnings. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. 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.