It is hard to get excited after looking at Cohort's (LON:CHRT) recent performance, when its stock has declined 20% over the past three months. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Cohort'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Cohort

How Is ROE Calculated?

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 Cohort is:

5.4% = UK£4.4m ÷ UK£81m (Based on the trailing twelve months to October 2021).

The 'return' refers to a company's earnings over the last year. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.05.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

Cohort's Earnings Growth And 5.4% ROE

On the face of it, Cohort's ROE is not much to talk about. Next, when compared to the average industry ROE of 9.2%, the company's ROE leaves us feeling even less enthusiastic. However, the moderate 7.1% net income growth seen by Cohort over the past five years is definitely a positive. So, the growth in the company's earnings could probably have been caused by other variables. Such as - high earnings retention or an efficient management in place.

We then performed a comparison between Cohort's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 7.1% in the same period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for CHRT? You can find out in our latest intrinsic value infographic research report.

Is Cohort Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 59% (or a retention ratio of 41%) for Cohort suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Moreover, Cohort is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 40% over the next three years. As a result, the expected drop in Cohort's payout ratio explains the anticipated rise in the company's future ROE to 16%, over the same period.

Conclusion

Overall, we feel that Cohort certainly does have some positive factors to consider. While no doubt its earnings growth is pretty substantial, we do feel that the reinvestment rate is pretty low, meaning, the earnings growth number could have been significantly higher had the company been retaining more of its profits. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.