Most readers would already be aware that Karat Packaging’s (NASDAQ:KRT) stock increased significantly by 5.8% over the past month. Given the company’s impressive performance, we decided to study its financial indicators more closely as a company’s financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on Karat Packaging’s ROE.
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.
How To Calculate Return On Equity?
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 Karat Packaging is:
19% = US$27m ÷ US$140m (Based on the trailing twelve months to March 2022).
The ‘return’ refers to a company’s earnings over the last year. One way to conceptualize this is that for each $1 of shareholders’ capital it has, the company made $0.19 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company’s future earnings. We now need to evaluate how much profit the company reinvests or “retains” for future growth which then gives us an idea about the growth potential of the company. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
A Side By Side comparison of Karat Packaging’s Earnings Growth And 19% ROE
To start with, Karat Packaging’s ROE looks acceptable. Further, the company’s ROE is similar to the industry average of 23%. This certainly adds some context to Karat Packaging’s exceptional 63% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company’s earnings growth. Such as – high earnings retention or an efficient management in place.
As a next step, we compared Karat Packaging’s 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 14%.
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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you’re wondering about Karat Packaging’s’s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Karat Packaging Using Its Retained Earnings Effectively?
While the company did pay out a portion of its dividend in the past, it currently doesn’t pay a dividend. This is likely what’s driving the high earnings growth number discussed above.
In total, we are pretty happy with Karat Packaging’s performance. In particular, it’s great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company’s earnings growth is expected to slow down. 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.
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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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