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It is hard to get excited after looking at Advanced Drainage Systems' (NYSE:WMS) recent performance, when its stock has declined 28% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Advanced Drainage Systems' ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
Check out our latest analysis for Advanced Drainage Systems
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Advanced Drainage Systems is:
36% = US$496m ÷ US$1.4b (Based on the trailing twelve months to September 2024).
The 'return' is the yearly profit. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.36 in profit.
What Has ROE Got To Do With 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.
Advanced Drainage Systems' Earnings Growth And 36% ROE
To begin with, Advanced Drainage Systems has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 18% the company's ROE is quite impressive. Under the circumstances, Advanced Drainage Systems' considerable five year net income growth of 46% was to be expected.
As a next step, we compared Advanced Drainage Systems' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 19%.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is WMS fairly valued? This infographic on the company's intrinsic value has everything you need to know.