Declining Stock and Solid Fundamentals: Is The Market Wrong About Capital Limited (LON:CAPD)?

With its stock down 5.3% over the past three months, it is easy to disregard Capital (LON:CAPD). 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. Particularly, we will be paying attention to Capital’s ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company’s shareholders.

See our latest analysis for Capital

How Do You Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for Capital is:

27% = US$62m ÷ US$227m (Based on the trailing twelve months to June 2022).

The ‘return’ is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each £1 of shareholders’ capital it has, the company made £0.27 in profit.

Why Is ROE Important For Earnings Growth?

So far, we’ve learned that ROE is a measure of a company’s profitability. 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 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.

Capital’s Earnings Growth And 27% ROE

Firstly, we acknowledge that Capital has a significantly high ROE. Additionally, the company’s ROE is higher compared to the industry average of 10% which is quite remarkable. So, the substantial 57% net income growth seen by Capital over the past five years isn’t overly surprising.

We then compared Capital’s net income growth with the industry and we’re pleased to see that the company’s growth figure is higher when compared with the industry which has a growth rate of 25% in the same period.

past-earnings-growth

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. If you’re wondering about Capital’s’s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Capital Efficiently Re-investing Its Profits?

Capital has a really low three-year median payout ratio of 12%, meaning that it has the remaining 88% left over to reinvest into its business. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Besides, Capital has been paying dividends over a period of eight years. This shows that the company is committed to sharing profits with its shareholders. Looking at the current analyst consensus data, we can see that the company’s future payout ratio is expected to rise to 18% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company’s expected ROE (to 14%) over the same period.

Summary

On the whole, we feel that Capital’s performance has been quite good. In particular, it’s great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. 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 latest analysts predictions for the company, check out this visualization of analyst forecasts 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.

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