With its stock down 3.0% over the past month, it is easy to disregard Acme United (NYSEMKT:ACU). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Acme United’s ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company’s management is utilizing the company’s capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How To 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 Acme United is:
11% = US$6.5m ÷ US$59m (Based on the trailing twelve months to June 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 learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or “retain”, we are then able to evaluate a company’s future ability to generate profits. 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.
Acme United’s Earnings Growth And 11% ROE
To begin with, Acme United seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 13%. Given the circumstances, we can’t help but wonder why Acme United saw little to no growth in the past five years. So, there could be some other aspects that could potentially be preventing the company from growing. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
As a next step, we compared Acme United’s net income growth with the industry and were disappointed to see that the company’s growth is lower than the industry average growth of 15% in the same period.
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. 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 Acme United is trading on a high P/E or a low P/E, relative to its industry.
Is Acme United Using Its Retained Earnings Effectively?
Despite having a moderate three-year median payout ratio of 32% (meaning the company retains68% of profits) in the last three-year period, Acme United’s earnings growth was more or les flat. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
Additionally, Acme United has paid dividends over a period of at least ten years, which means that the company’s management is determined to pay dividends even if it means little to no earnings growth.
Overall, we feel that Acme United certainly does have some positive factors to consider. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn’t the case here. This suggests that there might be some external threat to the business, that’s hampering its growth. Until now, we have only just grazed the surface of the company’s past performance by looking at the company’s fundamentals. To gain further insights into Acme United’s past profit growth, check out this visualization of past earnings, revenue and cash flows.
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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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