Caesarstone's (NASDAQ:CSTE) stock is up by a considerable 16% over the past three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. Specifically, we decided to study Caesarstone's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Caesarstone

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Caesarstone is:

1.9% = US$9.3m ÷ US$491m (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.02 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

A Side By Side comparison of Caesarstone's Earnings Growth And 1.9% ROE

It is quite clear that Caesarstone's ROE is rather low. Even when compared to the industry average of 18%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 44% seen by Caesarstone over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

That being said, we compared Caesarstone's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 5.9% in the same period.

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

Is Caesarstone Making Efficient Use Of Its Profits?

Despite having a normal three-year median payout ratio of 35% (where it is retaining 65% of its profits), Caesarstone has seen a decline in earnings as we saw above. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Only recently, Caesarstone stated paying a dividend. This likely means that the management might have concluded that its shareholders have a strong preference for dividends.

Conclusion

In total, we're a bit ambivalent about Caesarstone's performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. You can see the 4 risks we have identified for Caesarstone by visiting our risks dashboard for free on our platform here.

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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