Alfa Financial Software Holdings PLC's (LON:ALFA) Stock's On An Uptrend: Are Strong Financials Guiding The Market?

Most readers would already be aware that Alfa Financial Software Holdings' (LON:ALFA) stock increased significantly by 13% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. In this article, we decided to focus on Alfa Financial Software Holdings' ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Alfa Financial Software Holdings

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 Alfa Financial Software Holdings is:

50% = UK£22m ÷ UK£44m (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every £1 worth of shareholders' equity, the company generated £0.50 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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Alfa Financial Software Holdings' Earnings Growth And 50% ROE

Firstly, we acknowledge that Alfa Financial Software Holdings has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 10% which is quite remarkable. This likely paved the way for the modest 13% net income growth seen by Alfa Financial Software Holdings over the past five years.

Next, on comparing Alfa Financial Software Holdings' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 13% over the last few years.

Earnings growth is an important metric to consider when valuing a stock. 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. 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 Alfa Financial Software Holdings is trading on a high P/E or a low P/E, relative to its industry.

Is Alfa Financial Software Holdings Efficiently Re-investing Its Profits?

Alfa Financial Software Holdings has a low three-year median payout ratio of 15%, meaning that the company retains the remaining 85% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Besides, Alfa Financial Software Holdings has been paying dividends over a period of four years. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 18% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 38%, over the same period.

Conclusion

Overall, we are quite pleased with Alfa Financial Software Holdings' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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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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.