Archer-Daniels-Midland's (NYSE:ADM) stock up by 7.3% over the past three months. However, the company's financials look a bit inconsistent and market outcomes are ultimately driven by long-term fundamentals, meaning that the stock could head in either direction. Particularly, we will be paying attention to Archer-Daniels-Midland's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
See our latest analysis for Archer-Daniels-Midland
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 Archer-Daniels-Midland is:
8.2% = US$1.6b ÷ US$19b (Based on the trailing twelve months to September 2020).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.08 in profit.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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 Archer-Daniels-Midland's Earnings Growth And 8.2% ROE
At first glance, Archer-Daniels-Midland's ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 9.1%, we may spare it some thought. However, Archer-Daniels-Midland has seen a flattish net income growth over the past five years, which is not saying much. Bear in mind, the company's ROE is not very high. Hence, this provides some context to the flat earnings growth seen by the company.
Next, on comparing with the industry net income growth, we found that Archer-Daniels-Midland's earnings seems to be shrinking at a similar rate as the industry which shrunk at a rate of a rate of 0.5% 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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Archer-Daniels-Midland fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Archer-Daniels-Midland Using Its Retained Earnings Effectively?
In spite of a normal three-year median payout ratio of 46% (or a retention ratio of 54%), Archer-Daniels-Midland hasn't seen much growth in its earnings. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.
Additionally, Archer-Daniels-Midland 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 41% of its profits over the next three years. As a result, Archer-Daniels-Midland's ROE is not expected to change by much either, which we inferred from the analyst estimate of 9.1% for future ROE.
Conclusion
Overall, we have mixed feelings about Archer-Daniels-Midland. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.
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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