The stock of Advance Auto Parts (NYSE:AAP) has increased by 15% in the last three months, as most readers are already aware.
Given that stock prices are traditionally associated with a company’s long-term financial success, we wanted to dig deeper into its financial metrics to see if they played a role in the recent price movement.
In this article, we concentrated on Advance Auto Parts’ return on investment (ROI).
The return on equity, or ROE, is a measure of a company’s ability to increase its value and manage its investors’ assets.
To put it another way, it’s a profitability ratio that calculates the rate of return on the money invested by the company’s shareholders.
What is the formula for calculating return on investment (ROI)?
The ROE formula is as follows: Net Profit (from ongoing operations) x Shareholders’ Equity = Return on Equity
As a consequence of the above formula, Advance Auto Parts’ ROE is:
14 percent = $493 million (US$3.6 billion) (Based on the trailing twelve months to January 2021).
The profit over the previous twelve months is the’return.’
That means the company made $0.14 in profit for every $1 invested by its shareholders.
What Is The Connection Between Return On Investment And Earnings Growth?
ROE is an indicator of a company’s profitability, as we’ve seen so far.
We can then determine a company’s potential ability to produce income based on how much of its profits it decides to reinvest or “retain.”
Firms with a high return on equity and profit retention have a higher growth rate than firms without these characteristics, other things being equal.
Earnings Development And A 14% ROE At Advance Auto Parts
To begin with, Advance Auto Parts tends to have a respectable return on investment (ROI).
Regardless, the company’s ROE is also significantly smaller than the industry average of 18%.
Furthermore, Advance Auto Parts’ flat earnings over the last five years do not paint a very positive image.
Bear in mind that the company has a decent return on investment (ROI).
It’s just that the industry’s return on investment is higher.
As a consequence, other factors may be to blame for the flat earnings rise.
Low earnings retention or weak capital allocation are two examples.
Then, when we compared Advance Auto Parts’ reported growth to the industry’s 7.1 percent growth over the same span, we discovered that the company’s reported growth was lower, which is not something we like to see.
Stock valuation is heavily influenced by earnings growth.
The next move for investors is to see if the anticipated earnings growth, or lack thereof, is already factored into the share price.
This will allow them to determine if the stock’s future looks promising or ominous.
Has the market factored in AAP’s long-term prospects?
In our most recent intrinsic value infographic analysis study, you will learn more.
Is Advance Auto Parts Making Good Use of Its Retained Earnings?
Advance Auto Parts’ low three-year median payout ratio of 4.0 percent (meaning the company holds 96% of profits) should suggest that the company is holding the majority of its earnings and, as a result, should see better growth than it has reported.
Furthermore, Advance Auto Parts has paid dividends for at least ten years, indicating that the company’s management is committed to paying dividends even though earnings growth is minimal.
The company’s future payout ratio is forecast to grow to 9.4 percent over the next three years, according to current analyst consensus data.
Despite the anticipated improvement in the payout ratio, Advance Auto Parts’ future ROE is expected to rise to 22 percent.
Other factors, we infer, may be driving the expected rise in the company’s ROE.
Conclusion
Overall, we think Advance Auto Parts has a range of positive aspects to consider.
However, the company’s low earnings growth is troubling, particularly because it has a respectable rate of return and reinvests a significant portion of its income.
According to the appearances, there could be some other factors preventing growth that aren’t actually under the control of the company.
Having said that, we discovered that, based on current analyst forecasts, the company’s profits are projected to increase.
Are these analyst forecasts based on the industry’s general expectations or the company’s fundamentals?
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