Could The Market Be Wrong About Arad Investment & Industrial Development Ltd. (TLV:ARAD) Given Its Attractive Financial Prospects?

Arad Investment & Industrial Development (TLV:ARAD) has had a rough three months with its share price down 7.8%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Arad Investment & Industrial Development'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Arad Investment & Industrial Development

How Is ROE Calculated?

ROE can be calculated by using the formula:

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

So, based on the above formula, the ROE for Arad Investment & Industrial Development is:

19% = ₪980m ÷ ₪5.0b (Based on the trailing twelve months to September 2022).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each ₪1 of shareholders' capital it has, the company made ₪0.19 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

A Side By Side comparison of Arad Investment & Industrial Development's Earnings Growth And 19% ROE

To begin with, Arad Investment & Industrial Development seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 11%. This certainly adds some context to Arad Investment & Industrial Development's decent 16% net income growth seen over the past five years.

We then compared Arad Investment & Industrial Development's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 13% in the same period.

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). This then helps them determine if the stock is placed for a bright or bleak future. 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 Arad Investment & Industrial Development is trading on a high P/E or a low P/E, relative to its industry.

Is Arad Investment & Industrial Development Efficiently Re-investing Its Profits?

In Arad Investment & Industrial Development's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 7.4% (or a retention ratio of 93%), which suggests that the company is investing most of its profits to grow its business.

Besides, Arad Investment & Industrial Development has been paying dividends over a period of nine years. This shows that the company is committed to sharing profits with its shareholders.

Summary

Overall, we are quite pleased with Arad Investment & Industrial Development's 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. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. To know the 2 risks we have identified for Arad Investment & Industrial Development visit our risks dashboard for free.

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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.