Do Its Financials Have Any Role To Play In Driving Acme United Corporation's (NYSEMKT:ACU) Stock Up Recently?

Acme United's (NYSEMKT:ACU) stock is up by a considerable 36% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Acme United's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Acme United

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 Acme United is:

12% = US$7.0m ÷ US$61m (Based on the trailing twelve months to September 2020).

The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.12 in profit.

What Is The Relationship Between ROE And 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Acme United's Earnings Growth And 12% ROE

At first glance, Acme United seems to have a decent ROE. Even when compared to the industry average of 12% the company's ROE looks quite decent. Acme United's decent returns aren't reflected in Acme United'smediocre five year net income growth average of 2.4%. We reckon that a low growth, when returns are moderate could be the result of certain circumstances like low earnings retention or poor allocation of capital.

We then compared Acme United's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 14% in the same period, which is a bit concerning.

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 Acme United is trading on a high P/E or a low P/E, relative to its industry.

Is Acme United Making Efficient Use Of Its Profits?

Despite having a moderate three-year median payout ratio of 32% (implying that the company retains the remaining 68% of its income), Acme United's earnings growth was quite low. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Moreover, Acme United has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

On the whole, we do feel that Acme United has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard would have the 2 risks we have identified for Acme United.

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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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