Most readers would already know that Asaleo Care's (ASX:AHY) stock increased by 6.3% over the past three months. Given that the stock prices usually follow long-term business performance, we wonder if the company's mixed financials could have any adverse effect on its current price price movement Specifically, we decided to study Asaleo Care's 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. Put another way, it reveals the company's success at turning shareholder investments into profits.
Check out our latest analysis for Asaleo Care
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 Asaleo Care is:
16% = AU$28m ÷ AU$182m (Based on the trailing twelve months to December 2019).
The 'return' is the profit over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.16 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learnt that ROE is a measure of a company's profitability. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Asaleo Care's Earnings Growth And 16% ROE
To begin with, Asaleo Care seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 15%. For this reason, Asaleo Care's five year net income decline of 19% raises the question as to why the decent ROE didn't translate into growth. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
That being said, we compared Asaleo Care's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 3.1% in the same period.
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 Asaleo Care fairly valued compared to other companies? These 3 valuation measures might help you decide.