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Compass Group's (LON:CPG) stock up by 9.8% over the past three months. Given its impressive performance, we decided to study the company's key financial indicators as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Compass 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
See our latest analysis for Compass Group
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 Compass Group is:
20% = US$1.4b ÷ US$6.9b (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 £0.20.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.
Compass Group's Earnings Growth And 20% ROE
To begin with, Compass Group seems to have a respectable ROE. Especially when compared to the industry average of 7.9% the company's ROE looks pretty impressive. This certainly adds some context to Compass Group's exceptional 20% net income growth seen over the past five years. However, there could also be other causes behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.
We then performed a comparison between Compass Group's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 25% in the same 5-year period.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Compass Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.