Yahoo Finance Colefax Group PLC's (LON:CFX) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?
Colefax Group (LON:CFX) has had a rough three months with its share price down 22%. 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. Particularly, we will be paying attention to Colefax Group'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
View our latest analysis for Colefax Group
How To Calculate Return On Equity?
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 Colefax Group is:
12% = UK£3.3m ÷ UK£28m (Based on the trailing twelve months to October 2019).
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 £0.12 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learnt 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. 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.
Colefax Group's Earnings Growth And 12% ROE
To begin with, Colefax Group seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 13%. Despite the modest returns, Colefax Group's five year net income growth was quite low, averaging at only 2.8%. We reckon that a low growth, when returns are moderate could be the result of certain circumstances like low earnings retention or poor allocation of capital.
We then compared Colefax Group's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 16% in the same period, which is a bit concerning.
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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Colefax Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Colefax Group Using Its Retained Earnings Effectively?
A low three-year median payout ratio of 15% (implying that the company retains the remaining 85% of its income) suggests that Colefax Group is retaining most of its profits. This should be reflected in its earnings growth number, but that's not the case. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.
Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 16%.
Summary
On the whole, we do feel that Colefax Group has some positive attributes. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 2 risks we have identified for Colefax Group by visiting our risks dashboard for free on our platform here.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.
