Are City Service SE's (WSE:CTS) Mixed Financials Driving The Negative Sentiment?

Simply Wall St · 09/15/2023 04:09

City Service (WSE:CTS) has had a rough week with its share price down 12%. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. 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 City Service'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for City Service

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for City Service is:

22% = €4.5m ÷ €20m (Based on the trailing twelve months to June 2023).

The 'return' refers to a company's earnings over the last year. That means that for every PLN1 worth of shareholders' equity, the company generated PLN0.22 in profit.

What Is The Relationship Between ROE And 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 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.

City Service's Earnings Growth And 22% ROE

To begin with, City Service seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 12%. For this reason, City Service's five year net income decline of 24% raises the question as to why the high ROE didn't translate into earnings growth. Therefore, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.

That being said, we compared City Service's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 25% in the same 5-year period.

past-earnings-growth
WSE:CTS Past Earnings Growth September 15th 2023

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. Is City Service fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is City Service Making Efficient Use Of Its Profits?

While the company did payout a portion of its dividend in the past, it currently doesn't pay a dividend. This implies that potentially all of its profits are being reinvested in the business.

Summary

Overall, we have mixed feelings about City Service. Despite the high ROE, the company has a disappointing earnings growth number, due to its poor rate of reinvestment into its business. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. You can do your own research on City Service and see how it has performed in the past by looking at this FREE detailed graph of past earnings, revenue and cash flows.