American Woodmark (NASDAQ:AMWD) has had a rough three months with its share price down 27%. 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. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Specifically, we decided to study American Woodmark's ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
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 American Woodmark is:
7.9% = US$59m ÷ US$743m (Based on the trailing twelve months to April 2021).
The 'return' is the yearly profit. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.08 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
American Woodmark's Earnings Growth And 7.9% ROE
When you first look at it, American Woodmark's ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 17% either. Thus, the low net income growth of 2.1% seen by American Woodmark over the past five years could probably be the result of the low ROE.
We then compared American Woodmark's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 4.3% in the same period, which is a bit concerning.NasdaqGS:AMWD Past Earnings Growth July 15th 2021
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Is AMWD fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is American Woodmark Using Its Retained Earnings Effectively?
American Woodmark doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. However, this doesn't explain the low earnings growth the company has seen. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
On the whole, we feel that the performance shown by American Woodmark can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. 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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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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