California Water Service Group's (NYSE:CWT) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

California Water Service Group (NYSE:CWT) has had a rough three months with its share price down 3.9%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study California Water Service Group's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for California Water Service Group

How To Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for California Water Service Group is:

4.5% = US$62m ÷ US$1.4b (Based on the trailing twelve months to June 2023).

The 'return' is the income the business earned over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.04.

Why Is ROE Important For 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.

California Water Service Group's Earnings Growth And 4.5% ROE

When you first look at it, California Water Service Group's ROE doesn't look that attractive. Next, when compared to the average industry ROE of 8.6%, the company's ROE leaves us feeling even less enthusiastic. However, the moderate 8.3% net income growth seen by California Water Service Group over the past five years is definitely a positive. So, the growth in the company's earnings could probably have been caused by other variables. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

Next, on comparing California Water Service Group's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 8.4% over the last few years.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about California Water Service Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is California Water Service Group Efficiently Re-investing Its Profits?

California Water Service Group has a three-year median payout ratio of 47%, which implies that it retains the remaining 53% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Moreover, California Water Service Group 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 51% of its profits over the next three years. Regardless, the future ROE for California Water Service Group is predicted to rise to 8.5% despite there being not much change expected in its payout ratio.

Summary

On the whole, we do feel that California Water Service Group has some positive attributes. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.