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Alphabet's (NASDAQ:GOOGL) stock is up by 9.1% 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 Alphabet's ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
View our latest analysis for Alphabet
How Is ROE Calculated?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Alphabet is:
23% = US$61b ÷ US$267b (Based on the trailing twelve months to June 2023).
The 'return' is the profit over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.23 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. 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. 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.
Alphabet's Earnings Growth And 23% ROE
First thing first, we like that Alphabet has an impressive ROE. Secondly, even when compared to the industry average of 7.9% the company's ROE is quite impressive. Under the circumstances, Alphabet's considerable five year net income growth of 23% was to be expected.
As a next step, we compared Alphabet's 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 5.3%.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for GOOGL? You can find out in our latest intrinsic value infographic research report.