Most readers would already know that Canadian National Railway's (TSE:CNR) stock increased by 6.5% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Canadian National Railway's ROE today.
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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How To 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 Canadian National Railway is:
18% = CA$3.4b ÷ CA$19b (Based on the trailing twelve months to September 2020).
The 'return' is the income the business earned over the last year. That means that for every CA$1 worth of shareholders' equity, the company generated CA$0.18 in profit.
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. 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.
Canadian National Railway's Earnings Growth And 18% ROE
To begin with, Canadian National Railway seems to have a respectable ROE. Even when compared to the industry average of 15% the company's ROE looks quite decent. Despite the moderate return on equity, Canadian National Railway has posted a net income growth of 3.5% over the past five years. So, there could be some other factors at play that could be impacting the company's growth. For instance, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
As a next step, we compared Canadian National Railway's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 11% in the same period.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is Canadian National Railway fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Canadian National Railway Using Its Retained Earnings Effectively?
While Canadian National Railway has a decent three-year median payout ratio of 32% (or a retention ratio of 68%), it has seen very little growth in earnings. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.
Additionally, Canadian National Railway has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 36%. Still, forecasts suggest that Canadian National Railway's future ROE will rise to 22% even though the the company's payout ratio is not expected to change by much.
Overall, we feel that Canadian National Railway certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.
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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