Do Its Financials Have Any Role To Play In Driving Capital Appreciation Limited's (JSE:CTA) Stock Up Recently?

Capital Appreciation's (JSE:CTA) stock is up by a considerable 11% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Specifically, we decided to study Capital Appreciation's ROE in this article.

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.

See our latest analysis for Capital Appreciation

How Is ROE Calculated?

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 Capital Appreciation is:

11% = R146m ÷ R1.3b (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. That means that for every ZAR1 worth of shareholders' equity, the company generated ZAR0.11 in profit.

What Is The Relationship Between ROE And 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. 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.

Capital Appreciation's Earnings Growth And 11% ROE

It is hard to argue that Capital Appreciation's ROE is much good in and of itself. Not just that, even compared to the industry average of 19%, the company's ROE is entirely unremarkable. However, we we're pleasantly surprised to see that Capital Appreciation grew its net income at a significant rate of 24% in the last five years. Therefore, there could be other reasons behind this growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing Capital Appreciation's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 21% in the same period.

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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Capital Appreciation's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Capital Appreciation Making Efficient Use Of Its Profits?

Capital Appreciation's three-year median payout ratio is a pretty moderate 44%, meaning the company retains 56% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Capital Appreciation is reinvesting its earnings efficiently.

Besides, Capital Appreciation has been paying dividends over a period of three years. This shows that the company is committed to sharing profits with its shareholders.

Summary

In total, it does look like Capital Appreciation has some positive aspects to its business. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 2 risks we have identified for Capital Appreciation by visiting our risks dashboard for free on our platform here.

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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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