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Arcosa's (NYSE:ACA) stock is up by a considerable 34% 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. Particularly, we will be paying attention to Arcosa's 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Do You 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 Arcosa is:
6.2% = US$117m ÷ US$1.9b (Based on the trailing twelve months to September 2020).
The 'return' is the income the business earned over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.06 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.
Arcosa's Earnings Growth And 6.2% ROE
At first glance, Arcosa's ROE doesn't look very promising. 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 11%. As a result, Arcosa's flat net income growth over the past five years doesn't come as a surprise given its lower ROE.
Next, on comparing with the industry net income growth, we found that the industry grew its earnings by13% in the same period.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Arcosa's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Arcosa Using Its Retained Earnings Effectively?
Arcosa has a low three-year median payout ratio of 8.1% (or a retention ratio of 92%) but the negligible earnings growth number doesn't reflect this as high growth usually follows high profit retention.
Only recently, Arcosa started paying a dividend. This means that the management might have concluded that its shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 7.1%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 6.5%.
In total, we're a bit ambivalent about Arcosa's performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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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