It is hard to get excited after looking at Austin Engineering's (ASX:ANG) recent performance, when its stock has declined 9.3% over the past month. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Austin Engineering'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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Austin Engineering

How To Calculate Return On Equity?

ROE can be calculated by using the formula:

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

So, based on the above formula, the ROE for Austin Engineering is:

23% = AU$30m ÷ AU$130m (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.23.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Austin Engineering's Earnings Growth And 23% ROE

Firstly, we acknowledge that Austin Engineering has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 11% which is quite remarkable. So, the substantial 39% net income growth seen by Austin Engineering over the past five years isn't overly surprising.

Next, on comparing with the industry net income growth, we found that Austin Engineering's growth is quite high when compared to the industry average growth of 26% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Austin Engineering is trading on a high P/E or a low P/E, relative to its industry.

Is Austin Engineering Making Efficient Use Of Its Profits?

Austin Engineering has a really low three-year median payout ratio of 16%, meaning that it has the remaining 84% left over to reinvest into its business. So it looks like Austin Engineering is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Moreover, Austin Engineering is determined to keep sharing its profits with shareholders which we infer from its long history of four years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 32% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.

Summary

In total, we are pretty happy with Austin Engineering'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. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.