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Most readers would already know that Allied Farmers' (NZSE:ALF) stock increased by 9.3% 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. Specifically, we decided to study Allied Farmers' ROE in this article.
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 Allied Farmers
How Do You 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 Allied Farmers is:
20% = NZ$4.1m ÷ NZ$20m (Based on the trailing twelve months to December 2023).
The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every NZ$1 worth of equity, the company was able to earn NZ$0.20 in profit.
What Is The Relationship Between ROE And Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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.
Allied Farmers' Earnings Growth And 20% ROE
To begin with, Allied Farmers seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 9.7%. This certainly adds some context to Allied Farmers' exceptional 25% net income growth seen over the past five years. However, there could also be other causes behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.
When you consider the fact that the industry earnings have shrunk at a rate of 5.8% in the same 5-year period, the company's net income growth is pretty remarkable.
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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Allied Farmers fairly valued compared to other companies? These 3 valuation measures might help you decide.