Most readers would already be aware that Alphabet's (NASDAQ:GOOG.L) stock increased significantly by 18% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Particularly, we will be paying attention to Alphabet's ROE today.
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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Do You Calculate Return On Equity?
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 Alphabet is:
22% = US$51b ÷ US$230b (Based on the trailing twelve months to March 2021).
The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.22 in profit.
Why Is ROE Important For 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. 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.
A Side By Side comparison of Alphabet's Earnings Growth And 22% ROE
First thing first, we like that Alphabet has an impressive ROE. Secondly, even when compared to the industry average of 14% the company's ROE is quite impressive. As a result, Alphabet's exceptional 21% net income growth seen over the past five years, doesn't come as a surprise.
Next, on comparing Alphabet's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 24% in the same period.
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. Has the market priced in the future outlook for GOOG.L? You can find out in our latest intrinsic value infographic research report.
Is Alphabet Making Efficient Use Of Its Profits?
Overall, we are quite pleased with Alphabet'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. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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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