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It is hard to get excited after looking at CSL's (ASX:CSL) recent performance, when its stock has declined 5.3% over the past three months. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to CSL's ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
View our latest analysis for CSL
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 CSL is:
14% = US$2.7b ÷ US$19b (Based on the trailing twelve months to June 2024).
The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.14 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. 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.
CSL's Earnings Growth And 14% ROE
To begin with, CSL seems to have a respectable ROE. Especially when compared to the industry average of 9.4% the company's ROE looks pretty impressive. Despite this, CSL's five year net income growth was quite low averaging at only 3.2%. This is generally not the case as when a company has a high rate of return it should usually also have a high earnings growth rate. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.
Next, on comparing with the industry net income growth, we found that CSL's reported growth was lower than the industry growth of 13% over the last few years, which is not something we like to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for CSL? You can find out in our latest intrinsic value infographic research report.