Are Cass Information Systems, Inc.'s (NASDAQ:CASS) Mixed Financials Driving The Negative Sentiment?

With its stock down 1.9% over the past three months, it is easy to disregard Cass Information Systems (NASDAQ:CASS). It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on Cass Information Systems' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Cass Information Systems

How Is ROE Calculated?

ROE 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 Cass Information Systems is:

10% = US$25m ÷ US$251m (Based on the trailing twelve months to December 2020).

The 'return' refers to a company's earnings over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.10.

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. 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.

A Side By Side comparison of Cass Information Systems' Earnings Growth And 10% ROE

When you first look at it, Cass Information Systems' ROE doesn't look that attractive. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 14%. Accordingly, Cass Information Systems' low net income growth of 4.3% over the past five years can possibly be explained by the low ROE amongst other factors.

Next, on comparing with the industry net income growth, we found that Cass Information Systems' reported growth was lower than the industry growth of 11% in the same period, which is not something we like to see.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Cass Information Systems is trading on a high P/E or a low P/E, relative to its industry.

Is Cass Information Systems Efficiently Re-investing Its Profits?

Despite having a normal three-year median payout ratio of 47% (or a retention ratio of 53% over the past three years, Cass Information Systems has seen very little growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

In addition, Cass Information Systems has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Conclusion

Overall, we have mixed feelings about Cass Information Systems. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth.

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This article by Simply Wall St is general in nature. 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.
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