Yahoo Finance Are PZ Cussons Plc's (LON:PZC) Mixed Financials Driving The Negative Sentiment?
It is hard to get excited after looking at PZ Cussons' (LON:PZC) recent performance, when its stock has declined 17% over the past three months. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Specifically, we decided to study PZ Cussons' ROE in this article.
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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
View our latest analysis for PZ Cussons
How Do You 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 PZ Cussons is:
9.2% = UK£35m ÷ UK£382m (Based on the trailing twelve months to May 2021).
The 'return' refers to a company's earnings over the last year. That means that for every £1 worth of shareholders' equity, the company generated £0.09 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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.
PZ Cussons' Earnings Growth And 9.2% ROE
To begin with, PZ Cussons seems to have a respectable ROE. Even when compared to the industry average of 9.2% the company's ROE looks quite decent. As you might expect, the 23% net income decline reported by PZ Cussons is a bit of a surprise. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. These include low earnings retention or poor allocation of capital.
However, when we compared PZ Cussons' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 2.0% in the same period. This is quite worrisome.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is PZC worth today? The intrinsic value infographic in our free research report helps visualize whether PZC is currently mispriced by the market.
Is PZ Cussons Using Its Retained Earnings Effectively?
PZ Cussons' declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 98% (or a retention ratio of 1.9%). The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. Our risks dashboard should have the 2 risks we have identified for PZ Cussons.
Additionally, PZ Cussons 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 is expected to drop to 45% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 13%, over the same period.
Conclusion
On the whole, we feel that the performance shown by PZ Cussons can be open to many interpretations. While the company does have a high rate of return, its low earnings retention is probably what's hampering its earnings growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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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