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With its stock down 27% over the past three months, it is easy to disregard Aaron's Company (NYSE:AAN). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Aaron's Company's ROE.
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 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?
Return on equity 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 Aaron's Company is:
14% = US$105m ÷ US$734m (Based on the trailing twelve months to June 2021).
The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.14 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
A Side By Side comparison of Aaron's Company's Earnings Growth And 14% ROE
To start with, Aaron's Company's ROE looks acceptable. Be that as it may, the company's ROE is still quite lower than the industry average of 28%. Needless to say, the 36% net income shrink rate seen by Aaron's Companyover the past five years is a huge dampener. Not to forget, the company does have a high ROE to begin with, just that it is lower than the industry average. Therefore, the shrinking earnings could be the result of other factors. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
That being said, we compared Aaron's Company'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 14% 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. Is AAN fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Aaron's Company Making Efficient Use Of Its Profits?
Aaron's Company's low three-year median payout ratio of 5.0% (implying that it retains the remaining 95% of its profits) comes as a surprise when you pair it with the shrinking earnings. This typically shouldn't be the case when a company is retaining most of its earnings. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
In addition, Aaron's Company only recently started paying a dividend so the management probably decided the shareholders prefer dividends even though earnings have been shrinking.
On the whole, we do feel that Aaron's Company has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a moderate ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. With that said, we studied current analyst estimates and discovered that analysts expect the company's earnings growth to improve slightly. Sure enough, this could bring some relief to shareholders. 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. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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