It is hard to get excited after looking at ALLETE's (NYSE:ALE) recent performance, when its stock has declined 33% over the past three months. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. 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 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 ALLETE is:
7.9% = US$186m ÷ US$2.3b (Based on the trailing twelve months to December 2019).
The 'return' is the profit over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.08.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 7.9% ROE
When you first look at it, ALLETE's ROE doesn't look that attractive. However, its ROE is similar to the industry average of 9.5%, so we won't completely dismiss the company. On the other hand, ALLETE reported a moderate 7.8% net income growth over the past five years. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. For instance, the company has a low payout ratio or is being managed efficiently.
We then performed a comparison between ALLETE's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 7.3% 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). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about ALLETE's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is ALLETE Using Its Retained Earnings Effectively?
The high three-year median payout ratio of 66% (or a retention ratio of 34%) for ALLETE suggests that the company's growth wasn't really hampered despite it returning most of its income to its 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 66%. Accordingly, forecasts suggest that ALLETE's future ROE will be 8.8% which is again, similar to the current ROE.
In total, it does look like ALLETE has some positive aspects to its business. While no doubt its earnings growth is pretty substantial, we do feel that the reinvestment rate is pretty low, meaning, the earnings growth number could have been significantly higher had the company been retaining more of its profits. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned.
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