Alphabet (NASDAQ:GOOGL) has had a rough three months with its share price down 2.6%. 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 Alphabet’s ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company’s management is utilizing the company’s capital. Put another way, it reveals the company’s success at turning shareholder investments into profits.
See our latest analysis for Alphabet
How To Calculate Return On Equity?
Return on equity 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 Alphabet is:
29% = US$88b ÷ US$301b (Based on the trailing twelve months to June 2024).
The ‘return’ is the profit 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 $0.29 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. Based on how much of its profits the company chooses to reinvest or “retain”, we are then able to evaluate a company’s future ability to generate profits. 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.
Alphabet’s Earnings Growth And 29% ROE
First thing first, we like that Alphabet has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 6.7% also doesn’t go unnoticed by us. Probably as a result of this, Alphabet was able to see a decent net income growth of 18% over the last five years.
Next, on comparing with the industry net income growth, we found that Alphabet’s growth is quite high when compared to the industry average growth of 9.1% in the same period, which is great to see.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is GOOGL fairly valued? This infographic on the company’s intrinsic value has everything you need to know.
Is Alphabet Efficiently Re-investing Its Profits?
Alphabet has a low three-year median payout ratio of 2.8%, meaning that the company retains the remaining 97% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.
Our latest analyst data shows that the future payout ratio of the company is expected to rise to 9.7% over the next three years. However, the company’s ROE is not expected to change by much despite the higher expected payout ratio.
Summary
On the whole, we feel that Alphabet’s performance has been quite good. In particular, it’s great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, the company’s earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the company’s future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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.
