With its stock down 11% over the past month, it is easy to disregard American Software (NASDAQ:AMSW.A). We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. In this article, we decided to focus on American Software's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
Check out our latest analysis for American Software
How Is ROE Calculated?
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 American Software is:
9.0% = US$12m ÷ US$133m (Based on the trailing twelve months to July 2022).
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 $0.09 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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 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.
American Software's Earnings Growth And 9.0% ROE
When you first look at it, American Software's ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 12% either. Therefore, it might not be wrong to say that the five year net income decline of 8.9% seen by American Software was probably the result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
So, as a next step, we compared American Software's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 25% in the same period.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. What is AMSW.A worth today? The intrinsic value infographic in our free research report helps visualize whether AMSW.A is currently mispriced by the market.