ARB Corporation Limited's (ASX:ARB) Stock Has Shown A Decent Performance: Have Financials A Role To Play?

Simply Wall St · 10/17 20:25

ARB's (ASX:ARB) stock is up by 7.0% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to investigate if the company's decent financials had a hand to play in the recent price move. Particularly, we will be paying attention to ARB'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.

Check out our latest analysis for ARB

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for ARB is:

16% = AU$103m ÷ AU$659m (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.16 in profit.

What Has ROE Got To Do With 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 ARB's Earnings Growth And 16% ROE

To begin with, ARB seems to have a respectable ROE. Especially when compared to the industry average of 12% the company's ROE looks pretty impressive. Probably as a result of this, ARB was able to see a decent growth of 10% over the last five years.

As a next step, we compared ARB's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 16% in the same period.

past-earnings-growth
ASX:ARB Past Earnings Growth October 17th 2024

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. Is ARB fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is ARB Making Efficient Use Of Its Profits?

While ARB has a three-year median payout ratio of 52% (which means it retains 48% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.

Additionally, ARB has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 55%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 16%.

Conclusion

On the whole, we do feel that ARB has some positive attributes. Its earnings have grown respectably as we saw earlier, which was likely due to the company reinvesting its earnings at a pretty high rate of return. However, given the high ROE, we do think that the company is reinvesting a small portion of its profits. This could likely be preventing the company from growing to its full extent. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.