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ALLETE's (NYSE:ALE) stock is up by a considerable 15% over the past three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Specifically, we decided to study ALLETE's ROE in this article.
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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
View our latest analysis for ALLETE
How Is ROE Calculated?
Return on equity 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 ALLETE is:
5.4% = US$185m ÷ US$3.4b (Based on the trailing twelve months to September 2023).
The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.05 in profit.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.
A Side By Side comparison of ALLETE's Earnings Growth And 5.4% ROE
At first glance, ALLETE's ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 8.3% either. Accordingly, ALLETE's low net income growth of 2.8% over the past five years can possibly be explained by the low ROE amongst other factors.
Next, on comparing with the industry net income growth, we found that ALLETE's reported growth was lower than the industry growth of 6.1% over the last few years, which is not something we like to see.
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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about ALLETE's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is ALLETE Making Efficient Use Of Its Profits?
The high three-year median payout ratio of 78% (that is, the company retains only 22% of its income) over the past three years for ALLETE suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.