Amotiv (ASX:AOV) has had a rough week with its share price down 6.1%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Amotiv's ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Amotiv

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 Amotiv is:

11% = AU$100m ÷ AU$934m (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.11 in profit.

Why Is ROE Important For 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of Amotiv's Earnings Growth And 11% ROE

To begin with, Amotiv seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 12%. Consequently, this likely laid the ground for the decent growth of 16% seen over the past five years by Amotiv.

Next, on comparing Amotiv's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 16% over the last few years.

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 AOV fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Amotiv Efficiently Re-investing Its Profits?

Amotiv has a significant three-year median payout ratio of 87%, meaning that it is left with only 13% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Additionally, Amotiv 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 50% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 13%, over the same period.

Summary

In total, we are pretty happy with Amotiv's performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. 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.

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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.