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Is Chemring Group PLC's (LON:CHG) Latest Stock Performance Being Led By Its Strong Fundamentals?

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Chemring Group's (LON:CHG) stock up by 7.9% over the past three months. Since the market usually pay for a company’s long-term financial health, we decided to study the company’s fundamentals to see if they could be influencing the market. Specifically, we decided to study Chemring Group'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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Chemring Group

How Is ROE Calculated?

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 Chemring Group is:

12% = UK£40m ÷ UK£337m (Based on the trailing twelve months to April 2021).

The 'return' is the amount earned after tax over the last twelve months. That means that for every £1 worth of shareholders' equity, the company generated £0.12 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Chemring Group's Earnings Growth And 12% ROE

To start with, Chemring Group's ROE looks acceptable. On comparing with the average industry ROE of 9.1% the company's ROE looks pretty remarkable. This probably laid the ground for Chemring Group's significant 40% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Chemring Group's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 4.6%.

past-earnings-growth
past-earnings-growth

Earnings growth is a huge factor in stock valuation. 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. Has the market priced in the future outlook for CHG? You can find out in our latest intrinsic value infographic research report.

Is Chemring Group Using Its Retained Earnings Effectively?

Chemring Group's three-year median payout ratio is a pretty moderate 30%, meaning the company retains 70% of its income. So it seems that Chemring Group is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Besides, Chemring Group has been paying dividends for at least ten years or more. 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 38% over the next three years. However, the company's ROE is not expected to change by much despite the higher expected payout ratio.

Conclusion

On the whole, we feel that Chemring Group's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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. 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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