Many of our readers will already be aware that American Software’s (NASDAQ:AMSW.A) share price has risen significantly by 10% over the past month. However, while the market typically places emphasis on long term fundamentals, in this case those metrics look less promising, so we decided to take a closer look at the key financial metrics. In this article, we decided to focus on American Software’s ROE.
Return on equity (ROE) is a key factor to be considered by a shareholder because it tells them how efficiently their capital is being reinvested. Simply put, ROE is used to assess a company’s profitability relative to its own equity.
View our latest analysis for American Software
How to Calculate Return on Equity?
Return on equity can be calculated using the following formula:
Return on Equity = Net Income (from continuing operations) / Shareholders’ Equity
So, based on the above formula, American Software’s ROE is:
7.4% = US$9.7m ÷ US$130m (Based on the trailing 12 months to April 2024).
“Return” refers to annual profit, meaning that for every $1 of shareholders’ equity, the company generated $0.07 in profit.
What is the relationship between ROE and earnings growth?
Thus far, we’ve learned that ROE is a measure of a company’s profitability. Next, we need to evaluate how much of its profits the company reinvests or “retains” for future growth. This gives us an idea about a company’s growth potential. Assuming all else remains constant, the higher the ROE and retained profits, the better a company’s growth rate will be compared to companies that don’t necessarily have these characteristics.
American Software’s revenue growth and 7.4% ROE
At first glance, American Software’s ROE isn’t much to talk about. We then compared the company’s ROE with the wider industry, and were disappointed to see that its ROE is below the industry average of 12%. However, American Software has had modest net income growth of 11% over the past five years. Therefore, there may be other aspects that are positively impacting the company’s revenue growth. For example, the company’s management may have made good strategic decisions, or the company’s dividend payout ratio may be low.
As a next step, we compared American Software’s net income growth with the industry, which is disappointing as we found that the company’s growth was lower than the industry average of 13% over the same period.
Past Revenue Growth
The yardstick for valuing a company has a lot to do with its earnings growth rate. It’s important for investors to know if the market has priced in a company’s expected earnings growth (or decline) so they can tell if the stock is heading into brighter waters or if swampy waters await. If you’re wondering about American Software’s valuation, check out this metric of its price-to-earnings ratio compared to its industry.
The story continues
Is American Software making good use of its retained earnings?
American Software’s three-year median dividend payout ratio is high at 139%, suggesting the company is paying out more to shareholders in dividends than it is earning. However, as we’ve noted above, this doesn’t hinder the company’s growth potential. That said, it may be worth keeping an eye on a high dividend payout ratio in case the company is unable to maintain its current growth momentum. You can see the 3 risks we’ve identified for American Software by visiting our risks dashboard for free on our platform.
Additionally, American Software has been paying dividends for at least 10 years, which shows that the company is committed to sharing profits with shareholders.
Conclusion
Overall, we would think twice before deciding on any investment action regarding American Software. While the company’s earnings growth is undoubtedly quite respectable, its ROE and profit retention ratio are quite low. So, while the company has managed to grow earnings despite this, we are not sure if this growth will continue, especially in difficult times. That said, when we looked at the current analyst forecasts, we found that while the company has grown its earnings in the past, analysts are expecting earnings to decline in the future, which concerned us. To know more about the company’s future earnings growth forecasts, take a look at this free report on analyst forecasts for the company.
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This article by Simply Wall St is of general nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology, and our articles are not intended as financial advice. It is not a recommendation to buy or sell stocks, and does not take into account your objectives or financial situation. We aim to provide long-term analysis driven by fundamental data. Please note that our analysis may not take into account the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any of the stocks mentioned herein.
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