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Most readers would already be aware that Alexander & Baldwin's (NYSE:ALEX) stock increased significantly by 13% over the past three months. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimatley dictates market outcomes. In this article, we decided to focus on Alexander & Baldwin'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Is ROE Calculated?
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 Alexander & Baldwin is:
0.9% = US$11m ÷ US$1.1b (Based on the trailing twelve months to September 2020).
The 'return' is the amount earned after tax over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.01 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. 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 Alexander & Baldwin's Earnings Growth And 0.9% ROE
It is quite clear that Alexander & Baldwin's ROE is rather low. Even when compared to the industry average of 5.2%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 26% seen by Alexander & Baldwin over the last five years is not surprising. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.
That being said, we compared Alexander & Baldwin'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 12% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is ALEX worth today? The intrinsic value infographic in our free research report helps visualize whether ALEX is currently mispriced by the market.
Is Alexander & Baldwin Making Efficient Use Of Its Profits?
Alexander & Baldwin seems to be paying out most of its income as dividends judging by its LTM (or last twelve month) payout ratio of 56% (meaning, the company retains only 44% of profits). However, this is typical for REITs as they are often required by law to distribute most of their earnings. Accordingly, this likely explains why its earnings have been shrinking.
Additionally, Alexander & Baldwin has paid dividends over a period of seven years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 100% over the next three years. Still, forecasts suggest that Alexander & Baldwin's future ROE will rise to 5.5% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.
In total, we would have a hard think before deciding on any investment action concerning Alexander & Baldwin. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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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