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Altium Limited's (ASX:ALU) Stock Has Shown A Decent Performance: Have Financials A Role To Play?

editorial-team@simplywallst.com (Simply Wall St)
·3-min read

Most readers would already know that Altium's (ASX:ALU) stock increased by 4.0% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Altium's ROE.

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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Altium

How To Calculate Return On Equity?

ROE can be calculated by using the formula:

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

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So, based on the above formula, the ROE for Altium is:

22% = US$70m ÷ US$316m (Based on the trailing twelve months to December 2023).

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$0.22 in profit.

What Is The Relationship Between ROE And 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. 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.

Altium's Earnings Growth And 22% ROE

At first glance, Altium seems to have a decent ROE. On comparing with the average industry ROE of 11% the company's ROE looks pretty remarkable. Probably as a result of this, Altium was able to see a decent growth of 12% over the last five years.

As a next step, we compared Altium'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 25% in the same period.

past-earnings-growth
past-earnings-growth

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Altium's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Altium Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 77% (or a retention ratio of 23%) for Altium suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Additionally, Altium 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 78%. Regardless, the future ROE for Altium is predicted to rise to 36% despite there being not much change expected in its payout ratio.

Summary

Overall, we feel that Altium certainly does have some positive factors to consider. The company has grown its earnings moderately as previously discussed. Still, the high ROE could have been even more beneficial to investors had the company been reinvesting more of its profits. As highlighted earlier, the current reinvestment rate appears to be quite low. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com