The Colonial Motor Company Limited's (NZSE:CMO) Stock's Been Going Strong: Could Weak Financials Mean The Market Will Coorect Its Share Price?
Most readers would already be aware that Colonial Motor's (NZSE:CMO) stock increased significantly by 20% 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 ultimatley dictates market outcomes. In this article, we decided to focus on Colonial Motor's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
See our latest analysis for Colonial Motor
How Is ROE Calculated?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Colonial Motor is:
9.9% = NZ$21m ÷ NZ$208m (Based on the trailing twelve months to December 2019).
The 'return' is the profit over the last twelve months. That means that for every NZ$1 worth of shareholders' equity, the company generated NZ$0.10 in profit.
What Is The Relationship Between ROE And 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
Colonial Motor's Earnings Growth And 9.9% ROE
On the face of it, Colonial Motor's ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 12%. On the other hand, Colonial Motor reported a fairly low 3.9% net income growth over the past five years. Bear in mind, the company's ROE is not very high . So this could also be one of the reasons behind the company's low growth in earnings.
As a next step, we compared Colonial Motor's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 12% 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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Colonial Motor fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Colonial Motor Efficiently Re-investing Its Profits?
The high three-year median payout ratio of 64% (that is, the company retains only 36% of its income) over the past three years for Colonial Motor suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.
Conclusion
On the whole, Colonial Motor's performance is quite a big let-down. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. In brief, we think the company is risky and investors should think twice before making any final judgement on this company. To know the 2 risks we have identified for Colonial Motor 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.
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