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It is hard to get excited after looking at Cargojet's (TSE:CJT) recent performance, when its stock has declined 19% over the past three months. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Cargojet's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Is ROE Calculated?
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 Cargojet is:
15% = CA$108m ÷ CA$738m (Based on the trailing twelve months to December 2024).
The 'return' is the profit over the last twelve months. That means that for every CA$1 worth of shareholders' equity, the company generated CA$0.15 in profit.
Check out our latest analysis for Cargojet
What Has ROE Got To Do With 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. 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.
Cargojet's Earnings Growth And 15% ROE
To begin with, Cargojet seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 14%. This certainly adds some context to Cargojet's exceptional 26% net income growth seen over the past five years. However, there could also be other drivers behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.
As a next step, we compared Cargojet'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 10%.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Cargojet is trading on a high P/E or a low P/E, relative to its industry.