Cara Therapeutics (NASDAQ:CARA) has had a rough month with its share price down 8.8%. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Particularly, we will be paying attention to Cara Therapeutics' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Cara Therapeutics

How To Calculate Return On Equity?

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 Cara Therapeutics is:

4.1% = US$8.4m ÷ US$203m (Based on the trailing twelve months to June 2021).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.04.

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.

A Side By Side comparison of Cara Therapeutics' Earnings Growth And 4.1% ROE

When you first look at it, Cara Therapeutics' ROE doesn't look that attractive. Next, when compared to the average industry ROE of 19%, the company's ROE leaves us feeling even less enthusiastic. Thus, the low net income growth of 3.0% seen by Cara Therapeutics over the past five years could probably be the result of the low ROE.

We then compared Cara Therapeutics' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 10% in the same period, which is a bit concerning.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is Cara Therapeutics fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Cara Therapeutics Efficiently Re-investing Its Profits?

Cara Therapeutics doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. However, this doesn't explain the low earnings growth the company has seen. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Conclusion

On the whole, we feel that the performance shown by Cara Therapeutics can be open to many interpretations. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. 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.

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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