Natural Alternatives International, Inc. (NASDAQ:NAII) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?
Most readers would already be aware that Natural Alternatives International's (NASDAQ:NAII) stock increased significantly by 35% 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. Specifically, we decided to study Natural Alternatives International's ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.
Check out our latest analysis for Natural Alternatives International
How Do You Calculate Return On Equity?
ROE 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 Natural Alternatives International is:
0.7% = US$517k ÷ US$71m (Based on the trailing twelve months to September 2020).
The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.01.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
Natural Alternatives International's Earnings Growth And 0.7% ROE
It is hard to argue that Natural Alternatives International's ROE is much good in and of itself. Not just that, even compared to the industry average of 16%, the company's ROE is entirely unremarkable. Therefore, it might not be wrong to say that the five year net income decline of 25% seen by Natural Alternatives International was possibly a result of it having a lower ROE. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
That being said, we compared Natural Alternatives International's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 15% in the same period.
Earnings growth is a huge factor in stock valuation. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Natural Alternatives International is trading on a high P/E or a low P/E, relative to its industry.
Is Natural Alternatives International Efficiently Re-investing Its Profits?
Conclusion
On the whole, we feel that the performance shown by Natural Alternatives International can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. You can see the 6 risks we have identified for Natural Alternatives International by visiting our risks dashboard for free on our platform here.
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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