Declining Stock and Solid Fundamentals: Is The Market Wrong About ALS Limited (ASX:ALQ)?
ALS (ASX:ALQ) has had a rough three months with its share price down 6.8%. 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 ALS' 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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
See our latest analysis for ALS
How Is ROE Calculated?
Return on equity can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for ALS is:
20% = AU$276m ÷ AU$1.4b (Based on the trailing twelve months to March 2023).
The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.20 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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. 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.
ALS' Earnings Growth And 20% ROE
To start with, ALS' ROE looks acceptable. On comparing with the average industry ROE of 16% the company's ROE looks pretty remarkable. This certainly adds some context to ALS' decent 17% net income growth seen over the past five years.
We then compared ALS' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 13% in the same 5-year period.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for ALQ? You can find out in our latest intrinsic value infographic research report.
Is ALS Using Its Retained Earnings Effectively?
ALS has a significant three-year median payout ratio of 82%, meaning that it is left with only 18% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.
Besides, ALS has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 61% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.
Conclusion
On the whole, we feel that ALS' performance has been quite good. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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.
