Will Weakness in Calnex Solutions plc's (LON:CLX) Stock Prove Temporary Given Strong Fundamentals?

Calnex Solutions (LON:CLX) has had a rough three months with its share price down 34%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Calnex Solutions' ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Calnex Solutions

How Is ROE Calculated?

ROE 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 Calnex Solutions is:

22% = UK£5.9m ÷ UK£27m (Based on the trailing twelve months to March 2023).

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

What Has ROE Got To Do With Earnings Growth?

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

Calnex Solutions' Earnings Growth And 22% ROE

Firstly, we acknowledge that Calnex Solutions has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 16% which is quite remarkable. Under the circumstances, Calnex Solutions' considerable five year net income growth of 31% was to be expected.

As a next step, we compared Calnex Solutions' 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 25%.

past-earnings-growth

Earnings growth is a huge factor in stock valuation. 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 Calnex Solutions fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Calnex Solutions Using Its Retained Earnings Effectively?

Calnex Solutions' ' three-year median payout ratio is on the lower side at 12% implying that it is retaining a higher percentage (88%) of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

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. 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. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. Our risks dashboard will have the 1 risk we have identified for Calnex Solutions.

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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