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With its stock down 8.9% over the past month, it is easy to disregard Australian Agricultural Projects (ASX:AAP). 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 Australian Agricultural Projects' ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
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How Is ROE Calculated?
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 Australian Agricultural Projects is:
14% = AU$1.9m ÷ AU$14m (Based on the trailing twelve months to December 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$0.14.
See our latest analysis for Australian Agricultural Projects
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.
Australian Agricultural Projects' Earnings Growth And 14% ROE
To begin with, Australian Agricultural Projects seems to have a respectable ROE. On comparing with the average industry ROE of 5.0% the company's ROE looks pretty remarkable. Probably as a result of this, Australian Agricultural Projects was able to see an impressive net income growth of 64% over the last five years. However, there could also be other causes behind this growth. Such as - high earnings retention or an efficient management in place.
When you consider the fact that the industry earnings have shrunk at a rate of 2.0% in the same 5-year period, the company's net income growth is pretty remarkable.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. 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 Australian Agricultural Projects is trading on a high P/E or a low P/E, relative to its industry.