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Could The Market Be Wrong About American States Water Company (NYSE:AWR) Given Its Attractive Financial Prospects?

·4 min read

American States Water (NYSE:AWR) has had a rough three months with its share price down 15%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to American States Water'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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for American States Water

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 American States Water is:

13% = US$89m ÷ US$687m (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 $0.13.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

American States Water's Earnings Growth And 13% ROE

To start with, American States Water's ROE looks acceptable. On comparing with the average industry ROE of 9.2% the company's ROE looks pretty remarkable. This probably laid the ground for American States Water's moderate 9.0% net income growth seen over the past five years.

We then performed a comparison between American States Water's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 8.4% in the same period.

past-earnings-growth
past-earnings-growth

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about American States Water's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is American States Water Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 54% (or a retention ratio of 46%) for American States Water suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Additionally, American States Water has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 59%. Accordingly, forecasts suggest that American States Water's future ROE will be 14% which is again, similar to the current ROE.

Conclusion

In total, we are pretty happy with American States Water's performance. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.