It is hard to get excited after looking at Alamo Group's (NYSE:ALG) recent performance, when its stock has declined 7.4% over the past three months.   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.     Particularly, we will be paying attention to Alamo Group's  ROE today.  

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.

How Do You 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 Alamo Group is:

14% = US$135m ÷ US$957m (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit.  So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.14.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits.  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 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.

Alamo Group's Earnings Growth And 14% ROE  

To start with, Alamo Group's ROE looks acceptable.   And on comparing with the industry, we found that the the average industry ROE is similar at 14%.   Consequently, this likely laid the ground for the decent growth of 18% seen over the past five years by Alamo Group.    

Next, on comparing with the industry net income growth, we found that Alamo Group's growth is quite high when compared to the industry average growth of 8.0% in the same period, which is great to see.  

NYSE:ALG Past Earnings Growth June 4th 2024

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.    What is ALG worth today? The  intrinsic value infographic in our free research report  helps visualize whether ALG is currently mispriced by the market.  

Is Alamo Group Using Its Retained Earnings Effectively?  

Alamo Group has a low three-year median payout ratio of 8.4%, meaning that the company retains the remaining 92% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.  

Additionally, Alamo Group 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.  

Conclusion  

Overall, we are quite pleased with Alamo Group'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.     To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.