In This Article:
carsales.com's (ASX:CAR) stock up by 6.3% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on carsales.com'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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
See our latest analysis for carsales.com
How To 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 carsales.com is:
21% = AU$503m ÷ AU$2.4b (Based on the trailing twelve months to December 2022).
The 'return' is the income the business earned over the last year. That means that for every A$1 worth of shareholders' equity, the company generated 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. 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.
A Side By Side comparison of carsales.com's Earnings Growth And 21% ROE
To start with, carsales.com's ROE looks acceptable. Further, the company's ROE is similar to the industry average of 21%. This probably goes some way in explaining carsales.com's moderate 14% growth over the past five years amongst other factors.
As a next step, we compared carsales.com's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 22% in the same period.
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. This then helps them determine if the stock is placed for a bright or bleak future. 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 carsales.com is trading on a high P/E or a low P/E, relative to its industry.