Continental’s (ETR:CON) stock is up by a considerable 28% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company’s key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Continental’s 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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company’s shareholders.
Check out our latest analysis for Continental
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 Continental is:
7.3% = €1.0b ÷ €14b (Based on the trailing twelve months to September 2024).
The ‘return’ is the profit over the last twelve months. So, this means that for every €1 of its shareholder’s investments, the company generates a profit of €0.07.
We have already established that ROE serves as an efficient profit-generating gauge for a company’s future earnings. 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.
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 11%. In spite of this, Continental was able to grow its net income considerably, at a rate of 55% in the last five years. We reckon that there could be other factors at play here. Such as – high earnings retention or an efficient management in place.
As a next step, we compared Continental’s 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 31%.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company’s expected earnings growth (or decline). Doing so will help them establish if the stock’s future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Continental is trading on a high P/E or a low P/E, relative to its industry.
Continental’s three-year median payout ratio is a pretty moderate 45%, meaning the company retains 55% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Continental is reinvesting its earnings efficiently.
Besides, Continental has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 35% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company’s ROE to 14%, over the same period.
In total, it does look like Continental has some positive aspects to its business. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company’s earnings growth is expected to slow down. 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.