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ALS' (ASX:ALQ) stock up by 2.5% over the past week. As most would know, long-term fundamentals have a strong correlation with market price movements, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study ALS' ROE in this article.
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.
How To Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for ALS is:
16% = AU$174m ÷ AU$1.1b (Based on the trailing twelve months to March 2021).
The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.16 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.
ALS' Earnings Growth And 16% ROE
To begin with, ALS seems to have a respectable ROE. Even so, when compared with the average industry ROE of 21%, we aren't very excited. That being the case, the significant five-year 46% net income growth reported by ALS comes as a pleasant surprise. Therefore, there could be other causes behind this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this certainly also provides some context to the high earnings growth seen by the company.
As a next step, we compared ALS' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 17%.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about ALS''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is ALS Using Its Retained Earnings Effectively?
ALS' significant three-year median payout ratio of 78% (where it is retaining only 22% of its income) suggests that the company has been able to achieve a high growth in earnings despite returning most of its income to shareholders.
Moreover, ALS is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 59% over the next three years. As a result, the expected drop in ALS' payout ratio explains the anticipated rise in the company's future ROE to 21%, over the same period.
Overall, we feel that ALS certainly does have some positive factors to consider. Specifically, its respectable ROE which likely led to the considerable growth in earnings. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.
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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