Could The Market Be Wrong About Arcadis NV (AMS:ARCAD) Given Its Attractive Financial Prospects?

With its stock down 6.1% over the past three months, it is easy to disregard Arcadis (AMS:ARCAD). 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 Arcadis' 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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

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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:

20% = €242m ÷ €1.2b (Based on the trailing twelve months to December 2024).

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 €0.20 in profit.

Check out our latest analysis for Arcadis

What Is The Relationship Between ROE And 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. 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 20% ROE

To start with, Arcadis' ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 20%. This probably goes some way in explaining Arcadis' significant 36% net income growth over the past five years amongst other factors. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared Arcadis' 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 5-year 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. 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 Arcadis is trading on a high P/E or a low P/E, relative to its industry.

Is Arcadis Efficiently Re-investing Its Profits?

Arcadis has a three-year median payout ratio of 40% (where it is retaining 60% of its income) which is not too low or not too high. By the looks of it, the dividend is well covered and Arcadis is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Additionally, Arcadis has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 34% of its profits over the next three years. As a result, Arcadis' ROE is not expected to change by much either, which we inferred from the analyst estimate of 21% for future ROE.

Conclusion

Overall, we are quite pleased with Arcadis' performance. 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. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.