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Acme United's (NYSEMKT:ACU) stock up by 5.9% over the past three months. As most would know, long-term fundamentals have a strong correlation with market price movements, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Acme United's 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. 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 ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Acme United is:
11% = US$6.0m ÷ US$56m (Based on the trailing twelve months to March 2020).
The 'return' is the income the business earned over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.11.
What Has ROE Got To Do With Earnings Growth?
So far, we've learnt 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 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.
Acme United's Earnings Growth And 11% ROE
To begin with, Acme United seems to have a respectable ROE. Even so, when compared with the average industry ROE of 15%, we aren't very excited. Further, Acme United's five year net income growth of -1.1% is more or less flat. Bear in mind, the company does have a respectable level of ROE. It is just that the industry ROE is higher. Therefore, the flat earnings growth 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 competitve pressures.
Next, on comparing with the industry net income growth, we found that the industry grew its earnings by15% in the same period.
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. If you're wondering about Acme United's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Acme United Making Efficient Use Of Its Profits?
Despite having a normal three-year median payout ratio of 32% (implying that the company keeps 68% of its income) over the last three years, Acme United has seen a negligible amount of growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.
In addition, Acme United has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.
In total, it does look like Acme United has some positive aspects to its business. 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. Up till now, we've only made a short study of the company's growth data. So it may be worth checking this free detailed graph of Acme United's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.
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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