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ALLETE (NYSE:ALE) has had a rough three months with its share price down 14%. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. Specifically, we decided to study ALLETE's ROE in this article.
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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Do You 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 ALLETE is:
5.1% = US$145m ÷ US$2.8b (Based on the trailing twelve months to June 2021).
The 'return' is the income the business earned over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.05 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.
ALLETE's Earnings Growth And 5.1% ROE
When you first look at it, ALLETE's ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 10% either. Accordingly, ALLETE's low net income growth of 2.9% over the past five years can possibly be explained by the low ROE amongst other factors.
As a next step, we compared ALLETE'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 5.2% in the same period.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is ALE fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is ALLETE Efficiently Re-investing Its Profits?
The high three-year median payout ratio of 68% (that is, the company retains only 32% of its income) over the past three years for ALLETE suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.
Additionally, ALLETE has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 68% of its profits over the next three years. Regardless, the future ROE for ALLETE is predicted to rise to 8.0% despite there being not much change expected in its payout ratio.
Overall, we would be extremely cautious before making any decision on ALLETE. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. 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.
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.
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