Declining Stock and Decent Financials: Is The Market Wrong About Aristocrat Leisure Limited (ASX:ALL)?

With its stock down 4.9% over the past week, it is easy to disregard Aristocrat Leisure (ASX:ALL). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Aristocrat Leisure's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

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How Do You Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Aristocrat Leisure is:

16% = AU$1.2b ÷ AU$7.2b (Based on the trailing twelve months to March 2025).

The 'return' is the income the business earned over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.16.

See our latest analysis for Aristocrat Leisure

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Aristocrat Leisure's Earnings Growth And 16% ROE

To begin with, Aristocrat Leisure seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 6.0%. However, for some reason, the higher returns aren't reflected in Aristocrat Leisure's meagre five year net income growth average of 4.2%. That's a bit unexpected from a company which has such a high rate of return. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or poor allocation of capital.

Next, on comparing with the industry net income growth, we found that Aristocrat Leisure's reported growth was lower than the industry growth of 26% 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. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is ALL fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Aristocrat Leisure Using Its Retained Earnings Effectively?

Despite having a normal three-year median payout ratio of 35% (or a retention ratio of 65% over the past three years, Aristocrat Leisure has seen very little growth in earnings as we saw above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

In addition, Aristocrat Leisure has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 35%. Regardless, the future ROE for Aristocrat Leisure is predicted to rise to 25% despite there being not much change expected in its payout ratio.

Summary

On the whole, we do feel that Aristocrat Leisure has some positive attributes. 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. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.