Archer-Daniels-Midland (NYSE:ADM) has had a great run on the share market with its stock up by a significant 15% over the last three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Archer-Daniels-Midland's 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 Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Archer-Daniels-Midland is:
8.9% = US$1.8b ÷ US$20b (Based on the trailing twelve months to December 2020).
The 'return' is the income the business earned over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.09.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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.
Archer-Daniels-Midland's Earnings Growth And 8.9% ROE
On the face of it, Archer-Daniels-Midland's ROE is not much to talk about. However, its ROE is similar to the industry average of 10%, so we won't completely dismiss the company. Still, Archer-Daniels-Midland has seen a flat net income growth over the past five years. Bear in mind, the company's ROE is not very high. So that could also be one of the reasons behind the company's flat growth in earnings.
Given that the industry shrunk its earnings at a rate of 2.6% in the same period, the net income growth of the company is quite impressive.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for ADM? You can find out in our latest intrinsic value infographic research report.
Is Archer-Daniels-Midland Using Its Retained Earnings Effectively?
Despite having a moderate three-year median payout ratio of 46% (meaning the company retains54% of profits) in the last three-year period, Archer-Daniels-Midland's earnings growth was more or les flat. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.
Moreover, Archer-Daniels-Midland 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 43%. Accordingly, forecasts suggest that Archer-Daniels-Midland's future ROE will be 8.5% which is again, similar to the current ROE.
On the whole, we do feel that Archer-Daniels-Midland has some positive attributes. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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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