Continental (ETR:CON) has had a great run on the share market with its stock up by a significant 23% over the last three months. However, we wonder if the company’s inconsistent financials would have any adverse impact on the current share price momentum. In this article, we decided to focus on Continental’s ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company’s success at turning shareholder investments into profits.
See our latest analysis for Continental
How Do You Calculate Return On Equity?
ROE 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:
8.4% = €1.2b ÷ €15b (Based on the trailing twelve months to September 2023).
The ‘return’ is the yearly profit. That means that for every €1 worth of shareholders’ equity, the company generated €0.08 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. 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.
Continental’s Earnings Growth And 8.4% ROE
On the face of it, Continental’s ROE is not much to talk about. We then compared the company’s ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 14%. For this reason, Continental’s five year net income decline of 17% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
However, when we compared Continental’s growth with the industry we found that while the company’s earnings have been shrinking, the industry has seen an earnings growth of 17% in the same period. This is quite worrisome.
Earnings growth is a huge factor in stock valuation. 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 Continental fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Continental Making Efficient Use Of Its Profits?
In spite of a normal three-year median payout ratio of 41% (that is, a retention ratio of 59%), the fact that Continental’s earnings have shrunk is quite puzzling. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
Moreover, Continental has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts’ consensus data, we found that the company’s future payout ratio is expected to drop to 28% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company’s ROE to 16%, over the same period.
Summary
Overall, we have mixed feelings about Continental. While the company does have a high rate of profit retention, its low rate of return is probably hampering its 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. Are these analysts expectations based on the broad expectations for the industry, or on the company’s fundamentals? Click here to be taken to our analyst’s forecasts page 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.