Most readers would already be aware that AEM Holdings' (SGX:AWX) stock increased significantly by 14% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on AEM Holdings' ROE.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for AEM Holdings

How Is ROE Calculated?

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 AEM Holdings is:

32% = S$154m ÷ S$489m (Based on the trailing twelve months to September 2022).

The 'return' is the yearly profit. So, this means that for every SGD1 of its shareholder's investments, the company generates a profit of SGD0.32.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 AEM Holdings' Earnings Growth And 32% ROE

Firstly, we acknowledge that AEM Holdings has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 25% also doesn't go unnoticed by us. Under the circumstances, AEM Holdings' considerable five year net income growth of 32% was to be expected.

Next, on comparing AEM Holdings' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 29% in the same 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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about AEM Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is AEM Holdings Using Its Retained Earnings Effectively?

AEM Holdings has a really low three-year median payout ratio of 25%, meaning that it has the remaining 75% left over to reinvest into its business. So it looks like AEM Holdings is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Additionally, AEM Holdings 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 25%. Regardless, AEM Holdings' ROE is speculated to decline to 21% despite there being no anticipated change in its payout ratio.

Conclusion

In total, we are pretty happy with AEM Holdings' 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. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. 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.