Most readers would already be aware that CAR Group's (ASX:CAR) stock increased significantly by 16% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on CAR Group's ROE.
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. Put another way, it reveals the company's success at turning shareholder investments into profits.
View our latest analysis for CAR Group
How To Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for CAR Group is:
21% = AU$648m ÷ AU$3.1b (Based on the trailing twelve months to June 2023).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.21 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
CAR Group's Earnings Growth And 21% ROE
At first glance, CAR Group seems to have a decent ROE. Especially when compared to the industry average of 14% the company's ROE looks pretty impressive. This certainly adds some context to CAR Group's exceptional 30% net income growth seen over the past five years. We reckon that there could also be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.
As a next step, we compared CAR 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 28% in the same period.
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. Is CAR fairly valued? This infographic on the company's intrinsic value has everything you need to know.