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Could The Market Be Wrong About Canadian National Railway Company (TSE:CNR) Given Its Attractive Financial Prospects?

editorial-team@simplywallst.com (Simply Wall St)
·4-min read

It is hard to get excited after looking at Canadian National Railway's (TSE:CNR) recent performance, when its stock has declined 9.4% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Canadian National Railway'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Canadian National Railway

How To Calculate Return On Equity?

ROE can be calculated by using the formula:

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

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So, based on the above formula, the ROE for Canadian National Railway is:

28% = CA$5.5b ÷ CA$20b (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. Another way to think of that is that for every CA$1 worth of equity, the company was able to earn CA$0.28 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Canadian National Railway's Earnings Growth And 28% ROE

To begin with, Canadian National Railway has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 12% which is quite remarkable. This likely paved the way for the modest 6.8% net income growth seen by Canadian National Railway over the past five years.

As a next step, we compared Canadian National Railway's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 16% in the same period.

past-earnings-growth
past-earnings-growth

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. What is CNR worth today? The intrinsic value infographic in our free research report helps visualize whether CNR is currently mispriced by the market.

Is Canadian National Railway Efficiently Re-investing Its Profits?

Canadian National Railway has a three-year median payout ratio of 38%, which implies that it retains the remaining 62% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Besides, Canadian National Railway has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 37%. As a result, Canadian National Railway's ROE is not expected to change by much either, which we inferred from the analyst estimate of 30% for future ROE.

Summary

In total, we are pretty happy with Canadian National Railway's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see a good amount of growth in its earnings. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com