Combined Motor Holdings' (JSE:CMH) stock up by 4.4% over the past week. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Combined Motor Holdings' 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. Put another way, it reveals the company's success at turning shareholder investments into profits.
View our latest analysis for Combined Motor Holdings
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Combined Motor Holdings is:
33% = R414m ÷ R1.3b (Based on the trailing twelve months to August 2023).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each ZAR1 of shareholders' capital it has, the company made ZAR0.33 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned 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. 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.
A Side By Side comparison of Combined Motor Holdings' Earnings Growth And 33% ROE
To begin with, Combined Motor Holdings has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 19% which is quite remarkable. As a result, Combined Motor Holdings' exceptional 21% 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 Combined Motor Holdings' growth is quite high when compared to the industry average growth of 11% in the same period, which is great to see.
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). 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 Combined Motor Holdings is trading on a high P/E or a low P/E, relative to its industry.