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With its stock down 14% over the past three months, it is easy to disregard Arcosa (NYSE:ACA). It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Specifically, we decided to study Arcosa's 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. Put another way, it reveals the company's success at turning shareholder investments into profits.
How Is ROE Calculated?
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:
4.8% = US$91m ÷ US$1.9b (Based on the trailing twelve months to March 2021).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.05.
What Is The Relationship Between ROE And 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.
A Side By Side comparison of Arcosa's Earnings Growth And 4.8% ROE
At first glance, Arcosa's ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 9.6% either. Thus, the low net income growth of 3.6% seen by Arcosa over the past five years could probably be the result of the low ROE.
We then compared Arcosa's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 12% in the same period, which is a bit concerning.
Earnings growth is an important metric to consider when valuing a stock. 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 ACA fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Arcosa Using Its Retained Earnings Effectively?
A low three-year median payout ratio of 8.2% (implying that the company retains the remaining 92% of its income) suggests that Arcosa is retaining most of its profits. This should be reflected in its earnings growth number, but that's not the case. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
In addition, Arcosa only recently started paying a dividend so the management must have decided the shareholders prefer dividends over earnings growth.
Overall, we have mixed feelings about Arcosa. 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 analyst forecasts show that the company will continue to see an expansion in its earnings. 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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