Chemring Group (LON:CHG) has had a rough three months with its share price down 15%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study Chemring Group's ROE in this article.
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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
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 Chemring Group is:
12% = UK£43m ÷ UK£356m (Based on the trailing twelve months to October 2024).
The 'return' is the yearly profit. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.12 in profit.
What Is The Relationship Between ROE And Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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.
Chemring Group's Earnings Growth And 12% ROE
To begin with, Chemring Group seems to have a respectable ROE. Even so, when compared with the average industry ROE of 16%, we aren't very excited. Additionally, the low net income growth of 3.3% seen by Chemring Group over the past five years doesn't paint a very bright picture. Not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. Therefore, the low earnings growth could be the result of other factors. These include low earnings retention or poor capital allocation.
Next, on comparing with the industry net income growth, we found that Chemring Group's reported growth was lower than the industry growth of 13% over the last few years, which is not something we like to see.
LSE:CHG Past Earnings Growth January 16th 2025
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Chemring Group is trading on a high P/E or a low P/E, relative to its industry.
Is Chemring Group Using Its Retained Earnings Effectively?
Despite having a moderate three-year median payout ratio of 44% (implying that the company retains the remaining 56% of its income), Chemring Group's earnings growth was quite low. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.
In addition, Chemring Group has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 40%. However, Chemring Group's ROE is predicted to rise to 15% despite there being no anticipated change in its payout ratio.
Summary
On the whole, we do feel that Chemring Group has some positive attributes. However, while the company does have a decent ROE and a high profit retention, its earnings growth number is quite disappointing. This suggests that there might be some external threat to the business, that's hampering growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.
