Altium Limited's (ASX:ALU) Stock Is Going Strong: Have Financials A Role To Play?

Altium's (ASX:ALU) stock is up by a considerable 14% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study Altium'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Altium

How To 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 Altium is:

22% = US$66m ÷ US$304m (Based on the trailing twelve months to June 2023).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.22 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. 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.

A Side By Side comparison of Altium's Earnings Growth And 22% ROE

To begin with, Altium seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 9.4%. This probably laid the ground for Altium's moderate 8.5% net income growth seen over the past five years.

We then compared Altium's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 22% in the same 5-year period, which is a bit concerning.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. What is ALU worth today? The intrinsic value infographic in our free research report helps visualize whether ALU is currently mispriced by the market.

Is Altium Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 97% (or a retention ratio of 3.3%) for Altium suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Besides, Altium has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 70% over the next three years. The fact that the company's ROE is expected to rise to 33% over the same period is explained by the drop in the payout ratio.

Summary

On the whole, we do feel that Altium has some positive attributes. As noted earlier, its earnings growth has been quite decent, and the high ROE does contribute to that growth. Still, the company invests little to almost none of its profits. This could potentially reduce the odds that the company continues to see the same level of growth in the future. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.