Most readers would already be aware that Australian Clinical Labs' (ASX:ACL) stock increased significantly by 22% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Australian Clinical Labs' ROE in this article.
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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
Check out our latest analysis for Australian Clinical Labs
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Australian Clinical Labs is:
42% = AU$74m ÷ AU$175m (Based on the trailing twelve months to December 2022).
The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.42 in profit.
What Is The Relationship Between ROE And 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. 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.
A Side By Side comparison of Australian Clinical Labs' Earnings Growth And 42% ROE
To begin with, Australian Clinical Labs has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 6.3% which is quite remarkable. So, the substantial 41% net income growth seen by Australian Clinical Labs over the past five years isn't overly surprising.
Next, on comparing with the industry net income growth, we found that Australian Clinical Labs' growth is quite high when compared to the industry average growth of 11% in the same period, which is great to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Is Australian Clinical Labs fairly valued compared to other companies? These 3 valuation measures might help you decide.