Most readers would already be aware that Cake Box Holdings' (LON:CBOX) stock increased significantly by 19% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on Cake Box Holdings' ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Cake Box Holdings

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 Cake Box Holdings is:

30% = UK£3.4m ÷ UK£11m (Based on the trailing twelve months to March 2021).

The 'return' is the yearly profit. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.30 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Cake Box Holdings' Earnings Growth And 30% ROE

Firstly, we acknowledge that Cake Box Holdings has a significantly high ROE. Secondly, even when compared to the industry average of 23% the company's ROE is quite impressive. Probably as a result of this, Cake Box Holdings was able to see a decent net income growth of 15% over the last five years.

As a next step, we compared Cake Box Holdings' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 8.9%.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is CBOX fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Cake Box Holdings Making Efficient Use Of Its Profits?

Cake Box Holdings has a healthy combination of a moderate three-year median payout ratio of 34% (or a retention ratio of 66%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Besides, Cake Box Holdings has been paying dividends over a period of three years. This shows that the company is committed to sharing profits with its shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 49% over the next three years.

Conclusion

In total, we are pretty happy with Cake Box Holdings' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. To know the 1 risk we have identified for Cake Box Holdings visit our risks dashboard for free.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.