Does Chesnara plc's (LON:CSN) Weak Fundamentals Mean A Downturn In Its Stock Should Be Expected?

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

Wed, Feb 12, 2025, 12:33 AM 4 min read

Chesnara's (LON:CSN) stock up by 3.3% over the past three months. Given that the markets usually pay for the long-term financial health of a company, we wonder if the current momentum in the share price will keep up, given that the company's financials don't look very promising. Particularly, we will be paying attention to Chesnara's ROE today.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Chesnara

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 Chesnara is:

1.5% = UK£5.0m ÷ UK£330m (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.02.

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 Chesnara's Earnings Growth And 1.5% ROE

As you can see, Chesnara's ROE looks pretty weak. Not just that, even compared to the industry average of 14%, the company's ROE is entirely unremarkable. For this reason, Chesnara's five year net income decline of 44% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate of 21% over the last few years, we found that Chesnara's performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.

past-earnings-growth — LSE:CSN Past Earnings Growth February 12th 2025

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. 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 Chesnara is trading on a high P/E or a low P/E, relative to its industry.

Is Chesnara Efficiently Re-investing Its Profits?

Chesnara's high three-year median payout ratio of 124% suggests that the company is depleting its resources to keep up its dividend payments, and this shows in its shrinking earnings. Paying a dividend beyond their means is usually not viable over the long term. Our risks dashboard should have the 3 risks we have identified for Chesnara.

Moreover, Chesnara has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 64% over the next three years. As a result, the expected drop in Chesnara's payout ratio explains the anticipated rise in the company's future ROE to 17%, over the same period.

Summary

On the whole, Chesnara's performance is quite a big let-down. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.