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With its stock down 9.7% over the past three months, it is easy to disregard CSL (ASX:CSL). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study CSL's ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.
See our latest analysis for CSL
How Do You Calculate Return On Equity?
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 CSL is:
13% = US$2.2b ÷ US$18b (Based on the trailing twelve months to June 2023).
The 'return' is the profit over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.13 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.
A Side By Side comparison of CSL's Earnings Growth And 13% ROE
To begin with, CSL seems to have a respectable ROE. On comparing with the average industry ROE of 8.7% the company's ROE looks pretty remarkable. Despite this, CSL's five year net income growth was quite low averaging at only 4.7%. That's a bit unexpected from a company which has such a high rate of return. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.
Next, on comparing with the industry net income growth, we found that CSL's reported growth was lower than the industry growth of 15% over the last few years, which is not something we like to see.
Earnings growth is an important metric to consider when valuing a stock. 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. Is CSL fairly valued? This infographic on the company's intrinsic value has everything you need to know.