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Are Applied Industrial Technologies, Inc.'s (NYSE:AIT) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

With its stock down 8.4% over the past month, it is easy to disregard Applied Industrial Technologies (NYSE:AIT). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Applied Industrial Technologies' ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Applied Industrial Technologies

How Do You 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 Applied Industrial Technologies is:

22% = US$257m ÷ US$1.1b (Based on the trailing twelve months to June 2022).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.22 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. 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Applied Industrial Technologies' Earnings Growth And 22% ROE

First thing first, we like that Applied Industrial Technologies has an impressive ROE. Further, even comparing with the industry average if 22%, the company's ROE is quite respectable. However, for some reason, the higher returns aren't reflected in Applied Industrial Technologies' meagre five year net income growth average of 4.4%.Despite this, Applied Industrial Technologies' five year net income growth was quite low averaging at only 4.4%.Yet, Applied Industrial Technologies has posted measly growth of 4.4% over the past five years. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn't been able to do so. A few likely reasons why this could happen is that the company could have a high payout ratio the business has allocated capital poorly, for instance.

As a next step, we compared Applied Industrial Technologies' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 16% in the same period.

past-earnings-growth
past-earnings-growth

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Applied Industrial Technologies fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Applied Industrial Technologies Efficiently Re-investing Its Profits?

While Applied Industrial Technologies has a decent three-year median payout ratio of 35% (or a retention ratio of 65%), it has seen very little growth in earnings. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Moreover, Applied Industrial Technologies 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. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 19% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.

Summary

In total, it does look like Applied Industrial Technologies has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.

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

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.

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