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Most readers would already be aware that Automatic Data Processing's (NASDAQ:ADP) stock increased significantly by 6.7% over the past month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Particularly, we will be paying attention to Automatic Data Processing'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. Put another way, it reveals the company's success at turning shareholder investments into profits.
View our latest analysis for Automatic Data Processing
How Do You Calculate Return On Equity?
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 Automatic Data Processing is:
77% = US$3.9b ÷ US$5.1b (Based on the trailing twelve months to December 2024).
The 'return' refers to a company's earnings over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.77 in profit.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.
Automatic Data Processing's Earnings Growth And 77% ROE
First thing first, we like that Automatic Data Processing has an impressive ROE. Secondly, even when compared to the industry average of 19% the company's ROE is quite impressive. This likely paved the way for the modest 11% net income growth seen by Automatic Data Processing over the past five years.
As a next step, we compared Automatic Data Processing's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 11% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Automatic Data Processing is trading on a high P/E or a low P/E, relative to its industry.