With its stock down 6.7% over the past three months, it is easy to disregard Arcontech Group (LON:ARC). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Arcontech 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
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 Arcontech Group is:
19% = UK£1.2m ÷ UK£6.0m (Based on the trailing twelve months to December 2020).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.19 in profit.
What Has ROE Got To Do With 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 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 Arcontech Group's Earnings Growth And 19% ROE
To begin with, Arcontech Group seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 13%. Probably as a result of this, Arcontech Group was able to see an impressive net income growth of 25% over the last five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.
Next, on comparing with the industry net income growth, we found that Arcontech Group's growth is quite high when compared to the industry average growth of 14% in the same period, which is great to see.
Earnings growth is a huge factor in stock valuation. 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. Is ARC fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Arcontech Group Using Its Retained Earnings Effectively?
Arcontech Group's three-year median payout ratio is a pretty moderate 25%, meaning the company retains 75% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Arcontech Group is reinvesting its earnings efficiently.
Moreover, Arcontech Group is determined to keep sharing its profits with shareholders which we infer from its long history of four years of paying a dividend.
On the whole, we feel that Arcontech Group's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. 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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