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Most readers would already be aware that Austin Engineering's (ASX:ANG) stock increased significantly by 20% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Austin Engineering's ROE.
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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
View our latest analysis for Austin Engineering
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 Austin Engineering is:
13% = AU$15m ÷ AU$111m (Based on the trailing twelve months to December 2022).
The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.13 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. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
A Side By Side comparison of Austin Engineering's Earnings Growth And 13% ROE
At first glance, Austin Engineering seems to have a decent ROE. On comparing with the average industry ROE of 8.1% the company's ROE looks pretty remarkable. This probably laid the ground for Austin Engineering's significant 62% net income growth seen over the past five years. We reckon that there could also be other factors at play here. Such as - high earnings retention or an efficient management in place.
As a next step, we compared Austin Engineering'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 17%.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Austin Engineering's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.