Adbri (ASX:ABC) has had a rough three months with its share price down 26%. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. In this article, we decided to focus on Adbri's ROE.
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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
See our latest analysis for Adbri
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 Adbri is:
7.7% = AU$104m ÷ AU$1.4b (Based on the trailing twelve months to June 2023).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.08.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
Adbri's Earnings Growth And 7.7% ROE
On the face of it, Adbri's ROE is not much to talk about. However, given that the company's ROE is similar to the average industry ROE of 9.6%, we may spare it some thought. Having said that, Adbri's five year net income decline rate was 7.8%. Bear in mind, the company does have a slightly low ROE. Hence, this goes some way in explaining the shrinking earnings.
However, when we compared Adbri's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 3.0% in the same period. This is quite worrisome.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for ABC? You can find out in our latest intrinsic value infographic research report.