Most readers would already be aware that Alfa Financial Software Holdings' (LON:ALFA) stock increased significantly by 27% 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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Is ROE Calculated?
The formula for ROE 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:
34% = UK£21m ÷ UK£64m (Based on the trailing twelve months to June 2021).
The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.34 in profit.
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 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 34% ROE
First thing first, we like that Alfa Financial Software Holdings has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 9.7% also doesn't go unnoticed by us. However, for some reason, the higher returns aren't reflected in Alfa Financial Software Holdings' meagre five year net income growth average of 4.8%. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn't been able to do so. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.
As a next step, we compared Alfa Financial Software Holdings' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 4.9% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 Alfa Financial Software Holdings fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Alfa Financial Software Holdings Using Its Retained Earnings Effectively?
Alfa Financial Software Holdings' low three-year median payout ratio of 14% (or a retention ratio of 86%) should mean that the company is retaining most of its earnings to fuel its growth. This should be reflected in its earnings growth number, but that's not the case. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
Only recently, Alfa Financial Software Holdings started paying a dividend. This means that the management might have concluded that its shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 64% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.
On the whole, we feel that Alfa Financial Software Holdings' performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. 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.
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.
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