Australian Agricultural Projects (ASX:AAP) has had a great run on the share market with its stock up by a significant 27% over the last month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Australian Agricultural Projects' 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Australian Agricultural Projects

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 Australian Agricultural Projects is:

9.9% = AU$1.3m ÷ AU$13m (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.10 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 Australian Agricultural Projects' Earnings Growth And 9.9% ROE

At first glance, Australian Agricultural Projects' ROE doesn't look very promising. However, the fact that the its ROE is quite higher to the industry average of 5.8% doesn't go unnoticed by us. Particularly, the substantial 57% net income growth seen by Australian Agricultural Projects over the past five years is impressive . That being said, the company does have a slightly low ROE to begin with, just that it is higher than the industry average. So, there might well be other reasons for the earnings to grow. E.g the company has a low payout ratio or could belong to a high growth industry.

Next, on comparing with the industry net income growth, we found that the growth figure reported by Australian Agricultural Projects compares quite favourably to the industry average, which shows a decline of 2.9% 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 Australian Agricultural Projects fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Australian Agricultural Projects Using Its Retained Earnings Effectively?

Given that Australian Agricultural Projects doesn't pay any regular dividends to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.

Summary

Overall, we are quite pleased with Australian Agricultural Projects' performance. In particular, it's great to see that the company has seen significant growth in its earnings backed by a respectable ROE and a high reinvestment rate. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. You can see the 5 risks we have identified for Australian Agricultural Projects by visiting our risks dashboard for free on our platform here.

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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.