Profit ratio

The fundamentals of Cencosud SA (SNSE:CENCOSUD) seem quite solid: could the market be wrong about the stock?

With its stock down 12% over the past month, it’s easy to overlook Cencosud (SNSE: CENCOSUD). However, the company’s fundamentals look pretty decent and long-term financial data is generally in line with future market price movements. We will be particularly attentive today to the ROE of Cencosud.

Return on Equity or ROE is a test of how effectively a company increases its value and manages investors’ money. In other words, it is a profitability ratio that measures the rate of return on capital contributed by the company’s shareholders.

Discover our latest analysis for Cencosud

How to calculate return on equity?

The ROE formula is:

Return on equity = Net income (from continuing operations) ÷ Equity

So, based on the above formula, the ROE for Cencosud is:

12% = CL$569b ÷ CL$4.9t (Based on the last twelve months to March 2022).

The “yield” is the amount earned after tax over the last twelve months. This means that for every CLP1 of equity, the company generated a profit of 0.12 CLP.

What does ROE have to do with earnings growth?

We have already established that ROE serves as an effective profit-generating indicator for a company’s future earnings. Depending on how much of its profits the company chooses to reinvest or “keep”, we are then able to assess a company’s future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and earnings retention, the higher a company’s growth rate compared to companies that don’t necessarily exhibit these characteristics.

A side-by-side comparison of Cencosud’s earnings growth and 12% ROE

At first glance, Cencosud’s ROE does not look so attractive. However, the fact that its ROE is well above the industry average of 9.6% does not go unnoticed by us. But again, seeing that Cencosud’s net income has declined by 5.7% over the past five years makes us think again. Remember that the company’s ROE is a bit low to start with, just that it’s above the industry average. Therefore, lower revenue could also be the result.

So, in a next step, we compared the performance of Cencosud to that of the industry and were disappointed to discover that while the company reduced its profits, the industry increased its profits at a rate of 8.5 % over the same period.

SNSE:CENCOSUD Growth in past results May 29, 2022

Earnings growth is an important metric to consider when evaluating a stock. What investors then need to determine is whether the expected earnings growth, or lack thereof, is already priced into the stock price. By doing so, they will get an idea if the stock is headed for clear blue waters or if swampy waters are waiting. A 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 outlook. So, you might want to check if Cencosud is trading on a high P/E or a low P/E, relative to its industry.

Does Cencosud effectively reinvest its profits?

Cencosud’s low three-year median payout ratio of 17% (or an 83% retention rate) over the past three years should mean the company retains most of its earnings to fuel growth, but earnings of society have actually declined. This should generally not be the case when a company retains most of its profits. So there could be other explanations for this. For example, the company’s business may deteriorate.

Additionally, Cencosud has paid dividends over a period of at least ten years, which means the company’s management is committed to paying dividends even if it means little or no earnings growth. Looking at current analyst consensus data, we can see that the company’s future payout ratio is expected to reach 39% over the next three years. Anyway, the future ROE of Cencosud should reach 17% despite the anticipated increase in the payout rate. There could likely be other factors that could drive future ROE growth.

Conclusion

Overall, we believe that Cencosud has positive assets. However, although the company has a decent ROE and high earnings retention, its earnings growth figure is quite disappointing. This suggests that there could be an external threat to the business, which is hampering growth. That said, we studied the latest analyst forecasts and found that while the company has cut earnings in the past, analysts expect earnings to increase in the future. To learn more about the latest analyst forecasts for the company, check out this analyst forecast visualization for the company.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.