In This Article:
Allied Farmers (NZSE:ALF) has had a rough three months with its share price down 11%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Allied Farmers' ROE.
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.
Check out our latest analysis for Allied Farmers
How Do You Calculate Return On Equity?
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 Allied Farmers is:
24% = NZ$3.5m ÷ NZ$15m (Based on the trailing twelve months to December 2021).
The 'return' is the income the business earned over the last year. So, this means that for every NZ$1 of its shareholder's investments, the company generates a profit of NZ$0.24.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.
Allied Farmers' Earnings Growth And 24% ROE
To begin with, Allied Farmers has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 7.8% also doesn't go unnoticed by us. Probably as a result of this, Allied Farmers was able to see a decent net income growth of 5.3% over the last five years.
Next, on comparing Allied Farmers' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 5.3% in the same period.
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. 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 Allied Farmers is trading on a high P/E or a low P/E, relative to its industry.