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Most readers would already be aware that American Vanguard's (NYSE:AVD) stock increased significantly by 31% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study American Vanguard'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. Put another way, it reveals the company's success at turning shareholder investments into profits.
How To Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for American Vanguard is:
6.7% = US$25m ÷ US$383m (Based on the trailing twelve months to March 2022).
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 $0.07.
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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.
American Vanguard's Earnings Growth And 6.7% ROE
When you first look at it, American Vanguard's ROE doesn't look that attractive. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 17%. Therefore, American Vanguard's flat earnings over the past five years can possibly be explained by the low ROE amongst other factors.
As a next step, we compared American Vanguard's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 7.8% in the same period.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is American Vanguard fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is American Vanguard Making Efficient Use Of Its Profits?
American Vanguard's low three-year median payout ratio of 11% (implying that the company keeps89% of its income) should mean that the company is retaining most of its earnings to fuel its growth and this should be reflected in its growth number, but that's not the case.
Moreover, American Vanguard has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.
In total, we're a bit ambivalent about American Vanguard's performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.