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Are Robust Financials Driving The Recent Rally In Ashtead Group plc's (LON:AHT) Stock?

Ashtead Group (LON:AHT) has had a great run on the share market with its stock up by a significant 17% over the last three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Ashtead Group's ROE today.

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 Ashtead Group

How To Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Ashtead Group is:

21% = UK£697m ÷ UK£3.3b (Based on the trailing twelve months to April 2021).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.21 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

A Side By Side comparison of Ashtead Group's Earnings Growth And 21% ROE

To begin with, Ashtead Group has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 14% which is quite remarkable. This probably laid the groundwork for Ashtead Group's moderate 7.3% net income growth seen over the past five years.

Next, on comparing Ashtead Group's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 7.3% 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. Doing so will help them establish if the stock's future looks promising or ominous. Is AHT fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Ashtead Group Using Its Retained Earnings Effectively?

Ashtead Group has a low three-year median payout ratio of 23%, meaning that the company retains the remaining 77% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Besides, Ashtead Group has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 22% of its profits over the next three years. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 23%.

Summary

In total, we are pretty happy with Ashtead Group's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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.

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