Cashbuild Limited's (JSE:CSB) Stock's Been Going Strong: Could Weak Financials Mean The Market Will Correct Its Share Price?

Most readers would already be aware that Cashbuild's (JSE:CSB) stock increased significantly by 33% over the past three months. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. In this article, we decided to focus on Cashbuild's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Cashbuild

How To Calculate Return On Equity?

Return on equity 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 Cashbuild is:

4.8% = R88m ÷ R1.8b (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every ZAR1 worth of equity, the company was able to earn ZAR0.05 in profit.

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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Cashbuild's Earnings Growth And 4.8% ROE

It is quite clear that Cashbuild's ROE is rather low. Not just that, even compared to the industry average of 14%, the company's ROE is entirely unremarkable. Given the circumstances, the significant decline in net income by 23% seen by Cashbuild over the last five years is not surprising. We reckon that there could also be other factors at play here. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

However, when we compared Cashbuild's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 12% in the same period. This is quite worrisome.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Cashbuild's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Cashbuild Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 99% (implying that 1.4% of the profits are retained), most of Cashbuild's profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 2 risks we have identified for Cashbuild by visiting our risks dashboard for free on our platform here.

Additionally, Cashbuild has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Conclusion

On the whole, Cashbuild's performance is quite a big let-down. The low ROE, combined with the fact that the company is paying out almost if not all, of its profits as dividends, has resulted in the lack or absence of growth in its earnings. Up till now, we've only made a short study of the company's growth data. To gain further insights into Cashbuild's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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.