Acuity Brands (NYSE:AYI) has had a rough month with its share price down 8.2%. 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. Particularly, we will be paying attention to Acuity Brands' ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

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 Acuity Brands is:

18% = US$378m ÷ US$2.1b (Based on the trailing twelve months to February 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.18 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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.

Acuity Brands' Earnings Growth And 18% ROE

To start with, Acuity Brands' ROE looks acceptable. Even when compared to the industry average of 15% the company's ROE looks quite decent. This probably goes some way in explaining Acuity Brands' moderate 5.5% growth over the past five years amongst other factors.

We then compared Acuity Brands' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 15% in the same 5-year period, which is a bit concerning.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is AYI worth today? The intrinsic value infographic in our free research report helps visualize whether AYI is currently mispriced by the market.

Is Acuity Brands Using Its Retained Earnings Effectively?

In Acuity Brands' case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 4.8% (or a retention ratio of 95%), which suggests that the company is investing most of its profits to grow its business.

Besides, Acuity Brands has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 3.5% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.

Summary

On the whole, we feel that Acuity Brands' performance has been quite good. 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 respectable growth in its earnings. The latest industry analyst forecasts show that the company is expected to maintain 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.