Has Ampol Limited's (ASX:ALD) Impressive Stock Performance Got Anything to Do With Its Fundamentals?

Ampol (ASX:ALD) has had a great run on the share market with its stock up by a significant 6.4% over the last month. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to Ampol'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. 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 Ampol

How Do You Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for Ampol is:

19% = AU$779m ÷ AU$4.1b (Based on the trailing twelve months to December 2022).

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$0.19.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

Ampol's Earnings Growth And 19% ROE

At first glance, Ampol seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 20%. Despite this, Ampol's five year net income growth was quite flat over the past five years. So, there could be some other aspects that could potentially be preventing the company from growing. These include low earnings retention or poor allocation of capital.

We then compared Ampol's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 23% in the same period, which is a bit concerning.

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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Ampol's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Ampol Using Its Retained Earnings Effectively?

Despite having a moderate three-year median payout ratio of 41% (meaning the company retains59% of profits) in the last three-year period, Ampol's earnings growth was more or les flat. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, Ampol 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 is expected to rise to 68% over the next three years. Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.

Summary

In total, it does look like Ampol has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing 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.