CVS Group (LON:CVSG) has had a great run on the share market with its stock up by a significant 6.2% over the last week. 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. Particularly, we will be paying attention to CVS Group's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Do You 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 CVS Group is:
12% = UK£26m ÷ UK£205m (Based on the trailing twelve months to December 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 £0.12 in profit.
Why Is ROE Important For 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. 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.
A Side By Side comparison of CVS Group's Earnings Growth And 12% ROE
To begin with, CVS Group seems to have a respectable ROE. Especially when compared to the industry average of 10.0% the company's ROE looks pretty impressive. This certainly adds some context to CVS Group's decent 16% net income growth seen over the past five years.
As a next step, we compared CVS Group's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 16% in the same period.
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 CVSG fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is CVS Group Making Efficient Use Of Its Profits?
With a three-year median payout ratio of 37% (implying that the company retains 63% of its profits), it seems that CVS Group is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.
Additionally, CVS Group has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 10% over the next three years. The fact that the company's ROE is expected to rise to 25% over the same period is explained by the drop in the payout ratio.
Overall, we are quite pleased with CVS Group's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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.