Are Robust Financials Driving The Recent Rally In Packaging Corporation of America's (NYSE:PKG) Stock?

Packaging Corporation of America (NYSE:PKG) has had a great run on the share market with its stock up by a significant 18% over the last three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on Packaging Corporation of America's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Packaging Corporation of America

How Do You Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Packaging Corporation of America is:

21% = US$651m ÷ US$3.1b (Based on the trailing twelve months to March 2020).

The 'return' refers to a company's earnings over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.21.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learnt that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Packaging Corporation of America's Earnings Growth And 21% ROE

To start with, Packaging Corporation of America's ROE looks acceptable. On comparing with the average industry ROE of 16% the company's ROE looks pretty remarkable. This certainly adds some context to Packaging Corporation of America's decent 15% net income growth seen over the past five years.

We then performed a comparison between Packaging Corporation of America's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 14% in the same period.

Earnings growth is a huge factor in stock valuation. 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. Is PKG fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Packaging Corporation of America Efficiently Re-investing Its Profits?

With a three-year median payout ratio of 38% (implying that the company retains 62% of its profits), it seems that Packaging Corporation of America is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Besides, Packaging Corporation of America has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 51% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 15%, over the same period.

Summary

In total, we are pretty happy with Packaging Corporation of America's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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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