With its stock down 13% over the past month, it is easy to disregard Ashley Services Group (ASX:ASH). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Ashley Services Group's ROE today.
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 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 Ashley Services Group is:
25% = AU$6.2m ÷ AU$25m (Based on the trailing twelve months to January 2020).
The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.25 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learnt that ROE measures how efficiently a company is generating its profits. 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.
Ashley Services Group's Earnings Growth And 25% ROE
To begin with, Ashley Services Group has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 17% which is quite remarkable. So, the substantial 34% net income growth seen by Ashley Services Group over the past five years isn't overly surprising.
As a next step, we compared Ashley Services Group's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 25%.
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 Ashley Services Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Ashley Services Group Using Its Retained Earnings Effectively?
The high three-year median payout ratio of 69% (implying that it keeps only 31% of profits) for Ashley Services Group suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.
Additionally, Ashley Services Group has paid dividends over a period of five years which means that the company is pretty serious about sharing its profits with shareholders.
Overall, we are quite pleased with Ashley Services Group's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. So it may be worth checking this free detailed graph of Ashley Services Group's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.
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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