Yahoo Finance Arch Resources, Inc.'s (NYSE:ARCH) Stock On An Uptrend: Could Fundamentals Be Driving The Momentum?
Arch Resources (NYSE:ARCH) has had a great run on the share market with its stock up by a significant 46% over the last three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study Arch Resources' 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out our latest analysis for Arch Resources
How Is ROE Calculated?
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 Arch Resources is:
67% = US$615m ÷ US$924m (Based on the trailing twelve months to March 2022).
The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.67.
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.
A Side By Side comparison of Arch Resources' Earnings Growth And 67% ROE
Firstly, we acknowledge that Arch Resources has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 18% also doesn't go unnoticed by us. For this reason, Arch Resources' five year net income decline of 28% raises the question as to why the high ROE didn't translate into earnings growth. So, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.
Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate 7.1% in the same period, we found that Arch Resources' performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. What is ARCH worth today? The intrinsic value infographic in our free research report helps visualize whether ARCH is currently mispriced by the market.
Is Arch Resources Using Its Retained Earnings Effectively?
Arch Resources' low three-year median payout ratio of 1.2% (or a retention ratio of 99%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. This typically shouldn't be the case when a company is retaining most of its earnings. So there could be some other explanations in that regard. For example, the company's business may be deteriorating.
In addition, Arch Resources has been paying dividends over a period of five years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 100% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company's expected ROE (to 35%) over the same period.
Conclusion
On the whole, we do feel that Arch Resources has some positive attributes. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. Additionally, the latest industry analyst forecasts show that analysts expect the company's earnings to continue to shrink in the future. 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.
