Is Calnex Solutions plc's (LON:CLX) Recent Stock Performance Tethered To Its Strong Fundamentals?

Calnex Solutions (LON:CLX) has had a great run on the share market with its stock up by a significant 7.9% over the last month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Calnex Solutions' ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Calnex Solutions

How Do You Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Calnex Solutions is:

22% = UK£5.2m ÷ UK£24m (Based on the trailing twelve months to September 2022).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.22 in profit.

Why Is ROE Important For Earnings Growth?

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

Calnex Solutions' Earnings Growth And 22% ROE

Firstly, we acknowledge that Calnex Solutions has a significantly high ROE. Secondly, even when compared to the industry average of 14% the company's ROE is quite impressive. So, the substantial 33% net income growth seen by Calnex Solutions over the past five years isn't overly surprising.

We then performed a comparison between Calnex Solutions' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 30% in the same period.

past-earnings-growth

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 Calnex Solutions is trading on a high P/E or a low P/E, relative to its industry.

Is Calnex Solutions Making Efficient Use Of Its Profits?

Calnex Solutions' three-year median payout ratio to shareholders is 13%, which is quite low. This implies that the company is retaining 87% of its profits. So it looks like Calnex Solutions is reinvesting profits heavily to grow its business, which shows in its earnings growth.

While Calnex Solutions has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend.

Summary

On the whole, we feel that Calnex Solutions' performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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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