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ALS (ASX:ALQ) has had a great run on the share market with its stock up by a significant 9.9% over the last month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on ALS' ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How To Calculate Return On Equity?
Return on equity can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for ALS is:
16% = AU$180m ÷ AU$1.1b (Based on the trailing twelve months to September 2021).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.16 in profit.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.
ALS' Earnings Growth And 16% ROE
To begin with, ALS seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 12%. This probably laid the ground for ALS' significant 28% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.
Next, on comparing with the industry net income growth, we found that ALS' growth is quite high when compared to the industry average growth of 22% in the same period, which is great to see.
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). This then helps them determine if the stock is placed for a bright or bleak future. What is ALQ worth today? The intrinsic value infographic in our free research report helps visualize whether ALQ is currently mispriced by the market.
Is ALS Using Its Retained Earnings Effectively?
The high three-year median payout ratio of 74% (implying that it keeps only 26% of profits) for ALS suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 59%. However, ALS' ROE is predicted to rise to 23% despite there being no anticipated change in its payout ratio.
In total, we are pretty happy with ALS' performance. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. 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.
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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.