It is hard to get excited after looking at Armstrong World Industries' (NYSE:AWI) recent performance, when its stock has declined 14% over the past three months. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Armstrong World Industries' ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Armstrong World Industries is:
35% = US$265m ÷ US$757m (Based on the trailing twelve months to December 2024).
The 'return' is the income the business earned over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.35.
Check out our latest analysis for Armstrong World Industries
Why Is ROE Important For 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 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.
Armstrong World Industries' Earnings Growth And 35% ROE
Firstly, we acknowledge that Armstrong World Industries has a significantly high ROE. Secondly, even when compared to the industry average of 13% the company's ROE is quite impressive. As a result, Armstrong World Industries' exceptional 27% net income growth seen over the past five years, doesn't come as a surprise.
We then compared Armstrong World Industries' 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 16% in the same 5-year period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 AWI? You can find out in our latest intrinsic value infographic research report.
Is Armstrong World Industries Using Its Retained Earnings Effectively?
Armstrong World Industries' three-year median payout ratio to shareholders is 22%, which is quite low. This implies that the company is retaining 78% of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.
Moreover, Armstrong World Industries is determined to keep sharing its profits with shareholders which we infer from its long history of six years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 15% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.
Summary
Overall, we are quite pleased with Armstrong World Industries' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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.