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With its stock down 8.7% over the past month, it is easy to disregard Orica (ASX:ORI). Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. Specifically, we decided to study Orica's ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
View our latest analysis for Orica
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 Orica is:
5.9% = AU$227m ÷ AU$3.8b (Based on the trailing twelve months to March 2023).
The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.06 in profit.
What Is The Relationship Between ROE And 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.
Orica's Earnings Growth And 5.9% ROE
At first glance, Orica's ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 7.3%, we may spare it some thought. Having said that, Orica's five year net income decline rate was 5.7%. Bear in mind, the company does have a slightly low ROE. Therefore, the decline in earnings could also be the result of this.
That being said, we compared Orica's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 27% in the same period.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for ORI? You can find out in our latest intrinsic value infographic research report.