With its stock down 14% over the past three months, it is easy to disregard Action Construction Equipment (NSE:ACE). 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 Action Construction Equipment's ROE today.
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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How To Calculate Return On Equity?
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 Action Construction Equipment is:
16% = ₹1.1b ÷ ₹6.9b (Based on the trailing twelve months to September 2021).
The 'return' is the profit over the last twelve months. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.16.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.
Action Construction Equipment's Earnings Growth And 16% ROE
To begin with, Action Construction Equipment seems to have a respectable ROE. Especially when compared to the industry average of 12% the company's ROE looks pretty impressive. Probably as a result of this, Action Construction Equipment was able to see an impressive net income growth of 25% over the last five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
As a next step, we compared Action Construction Equipment's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 13%.
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. If you're wondering about Action Construction Equipment's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Action Construction Equipment Using Its Retained Earnings Effectively?
Action Construction Equipment has a really low three-year median payout ratio of 11%, meaning that it has the remaining 89% left over to reinvest into its business. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.
Moreover, Action Construction Equipment is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 6.0% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.
On the whole, we feel that Action Construction Equipment's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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.