Most readers would already be aware that Alto Ingredients' (NASDAQ:ALTO) stock increased significantly by 30% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Alto Ingredients' 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.
How Is ROE Calculated?
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 Alto Ingredients is:
13% = US$46m ÷ US$345m (Based on the trailing twelve months to December 2021).
The 'return' refers to a company's earnings over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.13.
Why Is ROE Important For 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. 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.
Alto Ingredients' Earnings Growth And 13% ROE
At first glance, Alto Ingredients seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 16%. Despite the moderate return on equity, Alto Ingredients has posted a net income growth of 4.1% over the past five years. 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.
Next, on comparing with the industry net income growth, we found that the growth figure reported by Alto Ingredients compares quite favourably to the industry average, which shows a decline of 10% in the same 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. What is ALTO worth today? The intrinsic value infographic in our free research report helps visualize whether ALTO is currently mispriced by the market.
Is Alto Ingredients Using Its Retained Earnings Effectively?
Alto Ingredients doesn't pay any dividend, which means that it is retaining all of its earnings. This doesn't explain the low earnings growth number that we discussed above. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
Overall, we are quite pleased with Alto Ingredients' 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. 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. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. To know the 2 risks we have identified for Alto Ingredients visit our risks dashboard for free.
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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.