Computer Modelling Group (TSE:CMG) has had a rough month with its share price down 10%. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Specifically, we decided to study Computer Modelling Group's ROE in this article.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Computer Modelling Group

How Is ROE Calculated?

ROE 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 Computer Modelling Group is:

54% = CA$22m ÷ CA$41m (Based on the trailing twelve months to September 2020).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each CA$1 of shareholders' capital it has, the company made CA$0.54 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Computer Modelling Group's Earnings Growth And 54% ROE

First thing first, we like that Computer Modelling Group has an impressive ROE. Secondly, even when compared to the industry average of 7.0% the company's ROE is quite impressive. Needless to say, we are quite surprised to see that Computer Modelling Group's net income shrunk at a rate of 4.7% over the past five years. We reckon that there could be some other factors at play here that are preventing the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

So, as a next step, we compared Computer Modelling Group's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 43% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Computer Modelling Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Computer Modelling Group Efficiently Re-investing Its Profits?

Computer Modelling Group's high three-year median payout ratio of 144% 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. To know the 2 risks we have identified for Computer Modelling Group visit our risks dashboard for free.

In addition, Computer Modelling 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.

Summary

Overall, we have mixed feelings about Computer Modelling Group. While the company does have a high rate of return, its low earnings retention is probably what's hampering its earnings growth. 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. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

This article by Simply Wall St is general in nature. 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.

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