Is Alphabet Inc.'s (NASDAQ:GOOG.L) Latest Stock Performance A Reflection Of Its Financial Health?

Alphabet's (NASDAQ:GOOG.L) stock is up by a considerable 17% 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 Alphabet's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Alphabet

How Do You Calculate Return On Equity?

Return on equity 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 Alphabet is:

18% = US$40b ÷ US$223b (Based on the trailing twelve months to December 2020).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.18 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Alphabet's Earnings Growth And 18% ROE

To start with, Alphabet's ROE looks acceptable. On comparing with the average industry ROE of 14% the company's ROE looks pretty remarkable. Probably as a result of this, Alphabet was able to see a decent growth of 19% over the last five years.

Next, on comparing with the industry net income growth, we found that Alphabet's reported growth was lower than the industry growth of 25% in the same period, which is not something we like to see.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. What is GOOG.L worth today? The intrinsic value infographic in our free research report helps visualize whether GOOG.L is currently mispriced by the market.

Is Alphabet Using Its Retained Earnings Effectively?

Conclusion

On the whole, we feel that Alphabet's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a respectable growth in its earnings. 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.

Promoted
If you’re looking to trade Alphabet, 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.