Alstom (EPA:ALO) has had a rough month with its share price down 21%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Alstom's ROE in this article.
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 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 Alstom is:
2.8% = €252m ÷ €9.1b (Based on the trailing twelve months to March 2021).
The 'return' is the yearly profit. Another way to think of that is that for every €1 worth of equity, the company was able to earn €0.03 in profit.
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. 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.
Alstom's Earnings Growth And 2.8% ROE
At first glance, Alstom's ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 3.9%. However, we we're pleasantly surprised to see that Alstom grew its net income at a significant rate of 50% in the last five years. Therefore, there could be other reasons behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.
Given that the industry shrunk its earnings at a rate of 2.2% in the same period, the net income growth of the company is quite impressive.
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. Is ALO fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Alstom Using Its Retained Earnings Effectively?
The three-year median payout ratio for Alstom is 27%, which is moderately low. The company is retaining the remaining 73%. By the looks of it, the dividend is well covered and Alstom is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.
Additionally, Alstom has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 26%. However, Alstom's ROE is predicted to rise to 10% despite there being no anticipated change in its payout ratio.
In total, it does look like Alstom has some positive aspects to its business. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
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