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With its stock down 13% over the past month, it is easy to disregard Alamo Group (NYSE:ALG). 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 Alamo Group's ROE today.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Alamo Group is:
11% = US$63m ÷ US$560m (Based on the trailing twelve months to March 2020).
The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.11 in profit.
Why Is ROE Important For Earnings Growth?
Thus far, we have learnt that ROE measures how efficiently a company is generating its profits. 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. 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.
Alamo Group's Earnings Growth And 11% ROE
To begin with, Alamo Group seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 13%. This probably goes some way in explaining Alamo Group's moderate 13% growth over the past five years amongst other factors.
As a next step, we compared Alamo Group's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 11% in the same period.
Earnings growth is an important metric to consider when valuing a stock. 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 Alamo Group is trading on a high P/E or a low P/E, relative to its industry.
Is Alamo Group Efficiently Re-investing Its Profits?
Alamo Group's three-year median payout ratio to shareholders is 9.1% (implying that it retains 91% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.
Moreover, Alamo Group is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.
On the whole, we feel that Alamo Group's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
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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