Yahoo Finance Are Strong Financial Prospects The Force That Is Driving The Momentum In Codan Limited's ASX:CDA) Stock?
Codan's (ASX:CDA) stock is up by a considerable 13% over the past month. 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. Specifically, we decided to study Codan's ROE in this article.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company's success at turning shareholder investments into profits.
View our latest analysis for Codan
How Is ROE Calculated?
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 Codan is:
26% = AU$64m ÷ AU$247m (Based on the trailing twelve months to June 2020).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.26 in profit.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
A Side By Side comparison of Codan's Earnings Growth And 26% ROE
Firstly, we acknowledge that Codan has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 13% which is quite remarkable. As a result, Codan's exceptional 27% net income growth seen over the past five years, doesn't come as a surprise.
Next, on comparing with the industry net income growth, we found that Codan's growth is quite high when compared to the industry average growth of 16% in the same period, which is great 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. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for CDA? You can find out in our latest intrinsic value infographic research report.
Is Codan Making Efficient Use Of Its Profits?
Codan's three-year median payout ratio is a pretty moderate 36%, meaning the company retains 64% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Codan is reinvesting its earnings efficiently.
Additionally, Codan has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 52% over the next three years. However, the company's ROE is not expected to change by much despite the higher expected payout ratio.
Conclusion
In total, we are pretty happy with Codan's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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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