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It is hard to get excited after looking at Alumasc Group's (LON:ALU) recent performance, when its stock has declined 29% over the past three months. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Alumasc Group's ROE.
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.
View our latest analysis for Alumasc Group
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 Alumasc Group is:
19% = UK£7.2m ÷ UK£38m (Based on the trailing twelve months to December 2021).
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 £0.19 in profit.
What Has ROE Got To Do With 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 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.
A Side By Side comparison of Alumasc Group's Earnings Growth And 19% ROE
To begin with, Alumasc Group seems to have a respectable ROE. Especially when compared to the industry average of 14% the company's ROE looks pretty impressive. Given the circumstances, we can't help but wonder why Alumasc Group saw little to no growth in the past five years. We reckon that there could be some other factors at play here that's limiting the company's growth. These include low earnings retention or poor allocation of capital.
Given that the industry shrunk its earnings at a rate of 6.6% in the same period, the net income growth of the company is quite impressive.
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). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Alumasc Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.