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Most readers would already know that ALLETE's (NYSE:ALE) stock increased by 2.8% over the past month. Given that the stock prices usually follow long-term business performance, we wonder if the company's mixed financials could have any adverse effect on its current price price movement Specifically, we decided to study ALLETE's ROE in this article.
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 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 ALLETE is:
5.8% = US$162m ÷ US$2.8b (Based on the trailing twelve months to December 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 $0.06 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. 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.
ALLETE's Earnings Growth And 5.8% ROE
When you first look at it, ALLETE's ROE doesn't look that attractive. Next, when compared to the average industry ROE of 9.4%, the company's ROE leaves us feeling even less enthusiastic. However, the moderate 5.0% net income growth seen by ALLETE over the past five years is definitely a positive. We reckon that there could be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.
We then compared ALLETE's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 6.9% in the same period, which is a bit concerning.
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 ALLETE fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is ALLETE Efficiently Re-investing Its Profits?
ALLETE has a significant three-year median payout ratio of 66%, meaning that it is left with only 34% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.
Besides, ALLETE has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 70%. Regardless, the future ROE for ALLETE is predicted to rise to 8.7% despite there being not much change expected in its payout ratio.
In total, we're a bit ambivalent about ALLETE's performance. While no doubt its earnings growth is pretty respectable, the low profit retention could mean that the company's earnings growth could have been higher, had it been paying reinvesting a higher portion of its profits. An improvement in its ROE could also help future earnings growth. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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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