CarGurus (NASDAQ:CARG) has had a great run on the share market with its stock up by a significant 64% over the last three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on CarGurus’ ROE.
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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How To 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 CarGurus is:
15% = US$42m ÷ US$278m (Based on the trailing twelve months to March 2020).
The ‘return’ is the profit over the last twelve months. So, this means that for every $1 of its shareholder’s investments, the company generates a profit of $0.15.
What Is The Relationship Between ROE And Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company’s future earnings. 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 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.
A Side By Side comparison of CarGurus’ Earnings Growth And 15% ROE
To begin with, CarGurus seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 14%. This certainly adds some context to CarGurus’ exceptional 67% net income growth seen over the past five years. However, there could also be other drivers behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.
We then compared CarGurus’ net income growth with the industry and we’re pleased to see that the company’s growth figure is higher when compared with the industry which has a growth rate of 31% in the same period.
Earnings growth is an important metric to consider when valuing a stock. 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. Is CARG fairly valued? This infographic on the company’s intrinsic value has everything you need to know.
Is CarGurus Using Its Retained Earnings Effectively?
CarGurus doesn’t pay any dividend to its shareholders, meaning that the company has been reinvesting all of its profits into the business. This is likely what’s driving the high earnings growth number discussed above.
In total, we are pretty happy with CarGurus’ performance. 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. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. To know more about the company’s future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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. Thank you for reading.