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With its stock down 25% over the past three months, it is easy to disregard ALE Property Group (ASX:LEP). To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. In this article, we decided to focus on ALE Property Group's ROE.
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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
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 ALE Property Group is:
6.9% = AU$42m ÷ AU$605m (Based on the trailing twelve months to December 2019).
The 'return' is the income the business earned over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.07.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learnt that ROE is a measure of a company's profitability. 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. 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.
ALE Property Group's Earnings Growth And 6.9% ROE
At first glance, ALE Property Group's ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 8.0%, we may spare it some thought. But ALE Property Group saw a five year net income decline of 13% over the past five years. Bear in mind, the company does have a slightly low ROE. Hence, this goes some way in explaining the shrinking earnings.
However, when we compared ALE Property Group's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 7.9% in the same period. This is quite worrisome.
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. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for LEP? You can find out in our latest intrinsic value infographic research report.
Is ALE Property Group Using Its Retained Earnings Effectively?
ALE Property Group's very high three-year median payout ratio of 127% over the last three years suggests that the company is paying its shareholders more than what it is earning and this explains the company's shrinking earnings. Paying a dividend beyond their means is usually not viable over the long term. Our risks dashboard should have the 4 risks we have identified for ALE Property Group.
Additionally, ALE Property Group has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 0.6% over the next three years. Still forecasts suggest that ALE Property Group's future ROE will drop to 5.4% even though the the company's payout ratio is expected to decrease. This suggests that there could be other factors could driving the anticipated decline in the company's ROE.
Overall, we would be extremely cautious before making any decision on ALE Property Group. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned.
We aim to bring you long-term focused research analysis driven by fundamental data. Note that our analysis may not factor in the latest price-sensitive company announcements or qualitative material. Thank you for reading.