With its stock down 4.6% over the past month, it is easy to disregard Arcadis (AMS:ARCAD). We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. In this article, we decided to focus on Arcadis' 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. Put another way, it reveals the company's success at turning shareholder investments into profits.
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 Arcadis is:
2.3% = €21m ÷ €910m (Based on the trailing twelve months to December 2020).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every €1 of its shareholder's investments, the company generates a profit of €0.02.
What Has ROE Got To Do With 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Arcadis' Earnings Growth And 2.3% ROE
When you first look at it, Arcadis' ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 13% either. For this reason, Arcadis' five year net income decline of 38% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.
That being said, we compared Arcadis' performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 14% in the same period.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is Arcadis fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Arcadis Using Its Retained Earnings Effectively?
Arcadis' declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 56% (or a retention ratio of 44%). With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. To know the 3 risks we have identified for Arcadis visit our risks dashboard for free.
Additionally, Arcadis has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 40% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 17%, over the same period.
On the whole, Arcadis' performance is quite a big let-down. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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This article by Simply Wall St is general in nature. 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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