Archer-Daniels-Midland's (NYSE:ADM) stock is up by a considerable 12% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Archer-Daniels-Midland's ROE in this article.

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.

See our latest analysis for Archer-Daniels-Midland

How To 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 Archer-Daniels-Midland is:

10.0% = US$2.1b ÷ US$21b (Based on the trailing twelve months to March 2021).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.10 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned 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.

A Side By Side comparison of Archer-Daniels-Midland's Earnings Growth And 10.0% ROE

On the face of it, Archer-Daniels-Midland's ROE is not much to talk about. However, given that the company's ROE is similar to the average industry ROE of 11%, we may spare it some thought. Having said that, Archer-Daniels-Midland has shown a meagre net income growth of 3.5% over the past five years. Bear in mind, the company's ROE is not very high . Hence, this does provide some context to low earnings growth seen by the company.

As a next step, we compared Archer-Daniels-Midland's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 0.5%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is ADM fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Archer-Daniels-Midland Efficiently Re-investing Its Profits?

While Archer-Daniels-Midland has a decent three-year median payout ratio of 46% (or a retention ratio of 54%), it has seen very little growth in earnings. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Moreover, Archer-Daniels-Midland has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 39% of its profits over the next three years. As a result, Archer-Daniels-Midland's ROE is not expected to change by much either, which we inferred from the analyst estimate of 9.6% for future ROE.

Summary

Overall, we feel that Archer-Daniels-Midland certainly does have some positive factors to consider. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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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