Continental (ETR:CON) has had a great run on the share market with its stock up by a significant 30% over the last three months. However, we decided to pay attention to the company’s fundamentals which don’t appear to give a clear sign about the company’s financial health. Specifically, we decided to study Continental’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.
Check out our latest analysis for Continental
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 Continental is:
0.8% = €112m ÷ €14b (Based on the trailing twelve months to December 2022).
The ‘return’ is the amount earned after tax over the last twelve months. So, this means that for every €1 of its shareholder’s investments, the company generates a profit of €0.01.
What Has ROE Got To Do With 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don’t have the same features.
A Side By Side comparison of Continental’s Earnings Growth And 0.8% ROE
It is hard to argue that Continental’s ROE is much good in and of itself. Even when compared to the industry average of 11%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 39% seen by Continental over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company’s earnings prospects. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.
Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate 11% in the same period, we found that Continental’s performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.
Earnings growth is an important metric to consider when valuing a stock. 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. Is Continental fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Continental Efficiently Re-investing Its Profits?
Conclusion
On the whole, we feel that the performance shown by Continental can be open to many interpretations. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. Having said that, looking at current analyst estimates, we found that the company’s earnings growth rate is expected to see a huge improvement. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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.
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