Conagra Brands (NYSE:CAG) has had a great run on the share market with its stock up by a significant 12% over the last three months. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. In this article, we decided to focus on Conagra Brands' ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

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 Conagra Brands is:

10% = US$951m ÷ US$9.2b (Based on the trailing twelve months to February 2024).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.10 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of Conagra Brands' Earnings Growth And 10% ROE

At first glance, Conagra Brands' ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 13% either. As a result, Conagra Brands reported a very low income growth of 2.9% over the past five years.

As a next step, we compared Conagra Brands' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 12% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 CAG fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Conagra Brands Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 66% (that is, the company retains only 34% of its income) over the past three years for Conagra Brands suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.

Additionally, Conagra Brands has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 52% over the next three years. As a result, the expected drop in Conagra Brands' payout ratio explains the anticipated rise in the company's future ROE to 14%, over the same period.

Conclusion

On the whole, Conagra Brands' performance is quite a big let-down. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.