With its stock down 8.8% over the past week, it is easy to disregard Alphabet (NASDAQ:GOOGL). 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. In this article, we decided to focus on Alphabet’s ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company’s management is utilizing the company’s capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How To Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for Alphabet is:
24% = US$67b ÷ US$273b (Based on the trailing twelve months to September 2023).
The ‘return’ is the profit over the last twelve months. One way to conceptualize this is that for each $1 of shareholders’ capital it has, the company made $0.24 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.
Alphabet’s Earnings Growth And 24% ROE
To begin with, Alphabet has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 7.2% the company’s ROE is quite impressive. So, the substantial 20% net income growth seen by Alphabet over the past five years isn’t overly surprising.
We then compared Alphabet’s net income growth with the industry and we’re pleased to see that the company’s growth figure is higher when compared with the industry which has a growth rate of 5.3% in the same 5-year period.
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. Has the market priced in the future outlook for GOOGL? You can find out in our latest intrinsic value infographic research report.
Is Alphabet Using Its Retained Earnings Effectively?
Alphabet doesn’t pay any dividend to its shareholders, meaning that the company has been reinvesting all of its profits into the business. This is likely what’s driving the high earnings growth number discussed above.
Overall, we are quite pleased with Alphabet’s performance. 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. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.