Karat Packaging (NASDAQ:KRT) has had a great run on the share market with its stock up by a significant 14% over the last three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Particularly, we will be paying attention to Karat Packaging’s ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company’s management is utilizing the company’s capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company’s shareholders.
Check out our latest analysis for Karat Packaging
How Is ROE Calculated?
Return on equity 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:
20% = US$33m ÷ US$163m (Based on the trailing twelve months to December 2023).
The ‘return’ is the yearly profit. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.20 in profit.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.
Karat Packaging’s Earnings Growth And 20% ROE
To begin with, Karat Packaging seems to have a respectable ROE. Further, the company’s ROE is similar to the industry average of 18%. This probably goes some way in explaining Karat Packaging’s significant 41% net income growth over the past five years amongst other factors. We reckon that there could also be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.
We then compared Karat Packaging’s 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 25% in the same 5-year period.
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. Is Karat Packaging fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Karat Packaging Using Its Retained Earnings Effectively?
Karat Packaging’s three-year median payout ratio to shareholders is 3.5%, which is quite low. This implies that the company is retaining 96% of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.
While Karat Packaging has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend.
Summary
Overall, we are quite pleased with Karat Packaging’s 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. Having said that, the company’s earnings growth is expected to slow down, as forecasted in the current analyst estimates. Are these analysts expectations based on the broad expectations for the industry, or on the company’s fundamentals? Click here to be taken to our analyst’s forecasts page for the company.
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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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