Yahoo Finance Advance Auto Parts, Inc.'s (NYSE:AAP) Stock On An Uptrend: Could Fundamentals Be Driving The Momentum?
Advance Auto Parts' (NYSE:AAP) stock is up by a considerable 5.1% over the past month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Advance Auto Parts' 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
View our latest analysis for Advance Auto Parts
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Advance Auto Parts is:
20% = US$570m ÷ US$2.9b (Based on the trailing twelve months to April 2022).
The 'return' is the income the business earned over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.20.
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 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 Advance Auto Parts' Earnings Growth And 20% ROE
To begin with, Advance Auto Parts seems to have a respectable ROE. Be that as it may, the company's ROE is still quite lower than the industry average of 31%. However, the moderate 8.0% net income growth seen by Advance Auto Parts over the past five years is definitely a positive. Therefore, the growth in earnings could probably have been caused by other variables. Such as - high earnings retention or an efficient management in place. Bear in mind, the company does have a respectable level of ROE. It is just that the industry ROE is higher. So this also does lend some color to the fairly high earnings growth seen by the company.
As a next step, we compared Advance Auto Parts' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 31% in the same period.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Is AAP fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Advance Auto Parts Using Its Retained Earnings Effectively?
Advance Auto Parts has a low three-year median payout ratio of 11%, meaning that the company retains the remaining 89% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.
Besides, Advance Auto Parts has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 41% over the next three years. However, Advance Auto Parts' future ROE is expected to rise to 30% despite the expected increase in the company's payout ratio. We infer that there could be other factors that could be driving the anticipated growth in the company's ROE.
Summary
On the whole, we do feel that Advance Auto Parts has some positive attributes. Particularly, its earnings have grown respectably as we saw earlier, which was likely achieved due to the company reinvesting most of its earnings at a decent rate of return, to grow its business. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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.
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