Acuity Brands (NYSE:AYI) has had a great run on the share market with its stock up by a significant 21% over the last three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on Acuity Brands' ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Acuity Brands is:
13% = US$271m ÷ US$2.1b (Based on the trailing twelve months to May 2020).
The 'return' refers to a company's earnings over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.13 in profit.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.
Acuity Brands' Earnings Growth And 13% ROE
At first glance, Acuity Brands seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 11%. This certainly adds some context to Acuity Brands' decent 5.8% net income growth seen over the past five years.
We then performed a comparison between Acuity Brands' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 6.7% in the same period.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Acuity Brands''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Acuity Brands Making Efficient Use Of Its Profits?
In Acuity Brands' case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 6.5% (or a retention ratio of 94%), which suggests that the company is investing most of its profits to grow its business.
Additionally, Acuity Brands has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 6.0% of its profits over the next three years. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 13%.
On the whole, we feel that Acuity Brands' performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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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