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It is hard to get excited after looking at Austin Engineering's (ASX:ANG) recent performance, when its stock has declined 9.3% over the past month. 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. Specifically, we decided to study Austin Engineering'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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
See our latest analysis for Austin Engineering
How To Calculate Return On Equity?
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 Austin Engineering is:
23% = AU$30m ÷ AU$130m (Based on the trailing twelve months to June 2024).
The 'return' is the yearly profit. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.23.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
Austin Engineering's Earnings Growth And 23% ROE
Firstly, we acknowledge that Austin Engineering has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 11% which is quite remarkable. So, the substantial 39% net income growth seen by Austin Engineering over the past five years isn't overly surprising.
Next, on comparing with the industry net income growth, we found that Austin Engineering's growth is quite high when compared to the industry average growth of 26% in the same period, which is great to see.
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 Austin Engineering is trading on a high P/E or a low P/E, relative to its industry.