With its stock down 35% over the past month, it is easy to disregard Alpha Pro Tech (NYSEMKT:APT). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Alpha Pro Tech's ROE in this article.
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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
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 Alpha Pro Tech is:
37% = US$20m ÷ US$55m (Based on the trailing twelve months to December 2020).
The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.37 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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 Alpha Pro Tech's Earnings Growth And 37% ROE
First thing first, we like that Alpha Pro Tech has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 16% also doesn't go unnoticed by us. Under the circumstances, Alpha Pro Tech's considerable five year net income growth of 44% was to be expected.
As a next step, we compared Alpha Pro Tech'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 6.1%.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Alpha Pro Tech is trading on a high P/E or a low P/E, relative to its industry.
Is Alpha Pro Tech Using Its Retained Earnings Effectively?
In total, we are pretty happy with Alpha Pro Tech's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial 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. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. Our risks dashboard would have the 2 risks we have identified for Alpha Pro Tech.
If you’re looking to trade Alpha Pro Tech, open an account with the lowest-cost* platform trusted by professionals, Interactive Brokers. Their clients from over 200 countries and territories trade stocks, options, futures, forex, bonds and funds worldwide from a single integrated account.
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.
*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.