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ALS Limited's (ASX:ALQ) Has Had A Decent Run On The Stock market: Are Fundamentals In The Driver's Seat?

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ALS' (ASX:ALQ) stock is up by 8.5% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to investigate if the company's decent financials had a hand to play in the recent price move. Particularly, we will be paying attention to ALS' ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for ALS

How To Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for ALS is:

5.8% = AU$61m ÷ AU$1.1b (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.06 in profit.

Why Is ROE Important For 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. 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 ALS' Earnings Growth And 5.8% ROE

At first glance, ALS' ROE doesn't look very promising. Next, when compared to the average industry ROE of 15%, the company's ROE leaves us feeling even less enthusiastic. In spite of this, ALS was able to grow its net income considerably, at a rate of 55% in the last five years. So, there might be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

We then compared ALS' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 10% in the same period.

past-earnings-growth
past-earnings-growth

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 ALS''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is ALS Using Its Retained Earnings Effectively?

ALS has a significant three-year median payout ratio of 85%, meaning the company only retains 15% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.

Besides, ALS has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 59% over the next three years. The fact that the company's ROE is expected to rise to 19% over the same period is explained by the drop in the payout ratio.

Conclusion

In total, it does look like ALS has some positive aspects to its business. That is, quite an impressive growth in earnings. However, the low profit retention means that the company's earnings growth could have been higher, had it been reinvesting a higher portion 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.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.