Most readers would already be aware that American Software’s (NASDAQ:AMSW.A) stock increased significantly by 10% over the past month. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don’t look very promising. In this article, we decided to focus on American Software’s ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for American Software

How To Calculate Return On Equity?

Return on equity 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 American Software is:

7.4% = US$9.7m ÷ US$130m (Based on the trailing twelve months to April 2024).

The ‘return’ is the yearly profit. That means that for every $1 worth of shareholders’ equity, the company generated $0.07 in profit.

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 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.

American Software’s Earnings Growth And 7.4% ROE

On the face of it, American Software’s ROE is not much to talk about. We then compared the company’s ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 12%. Although, we can see that American Software saw a modest net income growth of 11% over the past five years. So, there might be other aspects that are positively influencing the company’s earnings growth. For example, it is possible that the company’s management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared American Software’s net income growth with the industry and were disappointed to see that the company’s growth is lower than the industry average growth of 13% in the same period.

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. If you’re wondering about American Software’s’s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Story continues

Is American Software Using Its Retained Earnings Effectively?

American Software’s high three-year median payout ratio of 139% suggests that the company is paying out more to its shareholders than what it is making. However, this hasn’t really hampered its ability to grow as we saw earlier. That being said, the high payout ratio could be worth keeping an eye on in case the company is unable to keep up its current growth momentum. You can see the 3 risks we have identified for American Software by visiting our risks dashboard for free on our platform here.

Besides, American Software has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning American Software. While no doubt its earnings growth is pretty respectable, its ROE and earnings retention is quite poor. So while the company has managed to grow its earnings in spite of this, we are unconvinced if this growth could extend, specially during troubled times. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. 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.

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