Most readers would already be aware that Armstrong World Industries' (NYSE:AWI) stock increased significantly by 28% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Armstrong World Industries' ROE in this article.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

How To Calculate Return On Equity?

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 Armstrong World Industries is:

38% = US$224m ÷ US$592m (Based on the trailing twelve months to December 2023).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.38.

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. 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 Armstrong World Industries' Earnings Growth And 38% ROE

First thing first, we like that Armstrong World Industries has an impressive ROE. Secondly, even when compared to the industry average of 17% the company's ROE is quite impressive. This probably laid the groundwork for Armstrong World Industries' moderate 11% net income growth seen over the past five years.

We then performed a comparison between Armstrong World Industries' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 13% in the same 5-year period.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is AWI worth today? The intrinsic value infographic in our free research report helps visualize whether AWI is currently mispriced by the market.

Is Armstrong World Industries Using Its Retained Earnings Effectively?

Armstrong World Industries' three-year median payout ratio to shareholders is 22% (implying that it retains 78% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Moreover, Armstrong World Industries is determined to keep sharing its profits with shareholders which we infer from its long history of five years of paying a dividend. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 16% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.

Summary

In total, we are pretty happy with Armstrong World Industries' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. 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.

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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.