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Is Weakness In Cavco Industries, Inc. (NASDAQ:CVCO) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

With its stock down 11% over the past three months, it is easy to disregard Cavco Industries (NASDAQ:CVCO). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Cavco Industries' ROE.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Cavco Industries

How Do You 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 Cavco Industries is:

19% = US$195m ÷ US$1.0b (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.19.

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. 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.

Cavco Industries' Earnings Growth And 19% ROE

At first glance, Cavco Industries seems to have a decent ROE. Even when compared to the industry average of 16% the company's ROE looks quite decent. Consequently, this likely laid the ground for the impressive net income growth of 31% seen over the past five years by Cavco Industries. However, there could also be other drivers behind this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Cavco Industries' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 30% in the same period.

past-earnings-growth
past-earnings-growth

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Cavco Industries is trading on a high P/E or a low P/E, relative to its industry.

Is Cavco Industries Using Its Retained Earnings Effectively?

Given that Cavco Industries doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.

Summary

In total, we are pretty happy with Cavco Industries' 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. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.