Alamo Group (NYSE:ALG) has had a rough three months with its share price down 11%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Alamo Group's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How To 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 Alamo Group is:
9.1% = US$59m ÷ US$642m (Based on the trailing twelve months to March 2021).
The 'return' refers to a company's earnings over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.09.
What Has ROE Got To Do With 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 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.
Alamo Group's Earnings Growth And 9.1% ROE
At first glance, Alamo Group's ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 11% either. Although, we can see that Alamo Group saw a modest net income growth of 8.7% over the past five years. So, the growth in the company's earnings could probably have been caused by other variables. Such as - high earnings retention or an efficient management in place.
As a next step, we compared Alamo Group's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 8.1% in the same period.NYSE:ALG Past Earnings Growth July 23rd 2021
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Alamo Group is trading on a high P/E or a low P/E, relative to its industry.
Is Alamo Group Efficiently Re-investing Its Profits?
In Alamo Group's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 9.1% (or a retention ratio of 91%), which suggests that the company is investing most of its profits to grow its business.
Besides, Alamo Group has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.
Overall, we feel that Alamo Group certainly does have some positive factors to consider. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
This article by Simply Wall St is general in nature. It does not constitute a recommendation to buy or sell any stock, and does not take account of your objectives, or your financial situation. We aim to bring you long-term focused analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
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