Most readers would already be aware that Citadel Group's (ASX:CGL) stock increased significantly by 22% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Citadel Group'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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
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 Citadel Group is:
10% = AU$8.8m ÷ AU$85m (Based on the trailing twelve months to December 2019).
The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.10 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learnt 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.
Citadel Group's Earnings Growth And 10% ROE
At first glance, Citadel Group seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 12%. Consequently, this likely laid the ground for the decent growth of 11% seen over the past five years by Citadel Group.
As a next step, we compared Citadel Group's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 48% in the same period.
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). Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for CGL? You can find out in our latest intrinsic value infographic research report.
Is Citadel Group Using Its Retained Earnings Effectively?
The high three-year median payout ratio of 52% (or a retention ratio of 48%) for Citadel Group suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.
Moreover, Citadel Group is determined to keep sharing its profits with shareholders which we infer from its long history of five years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 47%. Accordingly, forecasts suggest that Citadel Group's future ROE will be 9.8% which is again, similar to the current ROE.
In total, it does look like Citadel Group has some positive aspects to its business. Its earnings have grown respectably as we saw earlier, which was likely due to the company reinvesting its earnings at a pretty high rate of return. However, given the high ROE, we do think that the company is reinvesting a small portion of its profits. This could likely be preventing the company from growing to its full extent. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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