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Will Weakness in Aristocrat Leisure Limited's (ASX:ALL) Stock Prove Temporary Given Strong Fundamentals?

With its stock down 8.5% over the past three months, it is easy to disregard Aristocrat Leisure (ASX:ALL). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Aristocrat Leisure's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Aristocrat Leisure

How Is ROE Calculated?

Return on equity 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 Aristocrat Leisure is:

16% = AU$949m ÷ AU$6.0b (Based on the trailing twelve months to September 2022).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.16 in profit.

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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Aristocrat Leisure's Earnings Growth And 16% ROE

To start with, Aristocrat Leisure's ROE looks acceptable. Especially when compared to the industry average of 12% the company's ROE looks pretty impressive. Probably as a result of this, Aristocrat Leisure was able to see a decent growth of 12% over the last five years.

Next, on comparing Aristocrat Leisure's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 11% in the same period.

past-earnings-growth
past-earnings-growth

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Aristocrat Leisure's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Aristocrat Leisure Using Its Retained Earnings Effectively?

Aristocrat Leisure has a healthy combination of a moderate three-year median payout ratio of 33% (or a retention ratio of 67%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Besides, Aristocrat Leisure has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 34% of its profits over the next three years. As a result, Aristocrat Leisure's ROE is not expected to change by much either, which we inferred from the analyst estimate of 19% for future ROE.

Conclusion

In total, we are pretty happy with Aristocrat Leisure's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. 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 latest analysts predictions for the company, check out this visualization of analyst forecasts 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.

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