Declining Stock and Solid Fundamentals: Is The Market Wrong About Aristocrat Leisure Limited (ASX:ALL)?

Simply Wall St

Sat, Jan 1, 2022, 2:04 PM 4 min read

Aristocrat Leisure (ASX:ALL) has had a rough three months with its share price down 3.1%. 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. Particularly, we will be paying attention to Aristocrat Leisure's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Aristocrat Leisure

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 Aristocrat Leisure is:

21% = AU$820m ÷ AU$3.9b (Based on the trailing twelve months to September 2021).

The 'return' is the amount earned after tax over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.21 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. 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.

Aristocrat Leisure's Earnings Growth And 21% ROE

At first glance, Aristocrat Leisure seems to have a decent ROE. On comparing with the average industry ROE of 10% the company's ROE looks pretty remarkable. Probably as a result of this, Aristocrat Leisure was able to see a decent growth of 19% over the last five years.

Given that the industry shrunk its earnings at a rate of 5.9% in the same period, the net income growth of the company is quite impressive.

past-earnings-growth — ASX:ALL Past Earnings Growth January 1st 2022

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. If you're wondering about Aristocrat Leisure's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Aristocrat Leisure Using Its Retained Earnings Effectively?

Aristocrat Leisure has a three-year median payout ratio of 38%, which implies that it retains the remaining 62% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Moreover, Aristocrat Leisure is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 38%. As a result, Aristocrat Leisure's ROE is not expected to change by much either, which we inferred from the analyst estimate of 23% for future ROE.

Summary

Overall, we are quite pleased with Aristocrat Leisure's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.