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Most readers would already know that Air Products and Chemicals' (NYSE:APD) stock increased by 8.1% over the past three months. Given its impressive performance, we decided to study the company's key financial indicators as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Air Products and Chemicals' ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.
See our latest analysis for Air Products and Chemicals
How To Calculate Return On Equity?
ROE 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 Air Products and Chemicals is:
15% = US$1.9b ÷ US$13b (Based on the trailing twelve months to December 2020).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.15 in profit.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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.
Air Products and Chemicals' Earnings Growth And 15% ROE
At first glance, Air Products and Chemicals seems to have a decent ROE. Especially when compared to the industry average of 10% the company's ROE looks pretty impressive. This certainly adds some context to Air Products and Chemicals' decent 14% net income growth seen over the past five years.
We then compared Air Products and Chemicals' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 5.4% in the same period.
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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Air Products and Chemicals is trading on a high P/E or a low P/E, relative to its industry.