Declining Stock and Decent Financials: Is The Market Wrong About Castings P.L.C. (LON:CGS)?

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editorial-team@simplywallst.com (Simply Wall St)

Sun, Jan 26, 2025, 12:07 AM 4 min read

Castings (LON:CGS) has had a rough three months with its share price down 14%. 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. In this article, we decided to focus on Castings' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Castings

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Castings is:

9.5% = UK£12m ÷ UK£128m (Based on the trailing twelve months to September 2024).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.09 in profit.

What Is The Relationship Between ROE And 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.

Castings' Earnings Growth And 9.5% ROE

At first glance, Castings' ROE doesn't look very promising. However, its ROE is similar to the industry average of 10%, so we won't completely dismiss the company. Having said that, Castings has shown a modest net income growth of 16% over the past five years. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Castings' 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 11%.

past-earnings-growth — LSE:CGS Past Earnings Growth January 26th 2025

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for CGS? You can find out in our latest intrinsic value infographic research report.

Is Castings Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 61% (or a retention ratio of 39%) for Castings suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Moreover, Castings is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 84% over the next three years.

Conclusion

Overall, we feel that Castings certainly does have some positive factors to consider. That is, quite an impressive growth in earnings. However, the low profit retention means that the company's earnings growth could have been higher, had it been reinvesting a higher portion of its profits. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. 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.