Packaging Corporation of America's (NYSE:PKG) Stock Is Going Strong: Have Financials A Role To Play?

Most readers would already be aware that Packaging Corporation of America's (NYSE:PKG) stock increased significantly by 17% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Packaging Corporation of America's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Packaging Corporation of America

How To 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 Packaging Corporation of America is:

17% = US$718m ÷ US$4.1b (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.17 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

A Side By Side comparison of Packaging Corporation of America's Earnings Growth And 17% ROE

To begin with, Packaging Corporation of America seems to have a respectable ROE. Even when compared to the industry average of 15% the company's ROE looks quite decent. This certainly adds some context to Packaging Corporation of America's moderate 6.7% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that Packaging Corporation of America's reported growth was lower than the industry growth of 9.5% 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. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is PKG fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Packaging Corporation of America Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 51% (or a retention ratio of 49%) for Packaging Corporation of America suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Moreover, Packaging Corporation of America is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. 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 46%. Accordingly, forecasts suggest that Packaging Corporation of America's future ROE will be 20% which is again, similar to the current ROE.

Summary

On the whole, we do feel that Packaging Corporation of America has some positive attributes. 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. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.