Declining Stock and Decent Financials: Is The Market Wrong About Art's-Way Manufacturing Co., Inc. (NASDAQ:ARTW)?

It is hard to get excited after looking at Art's-Way Manufacturing's (NASDAQ:ARTW) recent performance, when its stock has declined 42% over the past three months. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Art's-Way Manufacturing's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Art's-Way Manufacturing

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Art's-Way Manufacturing is:

1.2% = US$121k ÷ US$10.0m (Based on the trailing twelve months to February 2022).

The 'return' is the profit over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.01.

What Is The Relationship Between ROE And 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 Art's-Way Manufacturing's Earnings Growth And 1.2% ROE

As you can see, Art's-Way Manufacturing's ROE looks pretty weak. Even when compared to the industry average of 12%, the ROE figure is pretty disappointing. Although, we can see that Art's-Way Manufacturing saw a modest net income growth of 12% over the past five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Art's-Way Manufacturing's growth is quite high when compared to the industry average growth of 8.7% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Art's-Way Manufacturing is trading on a high P/E or a low P/E, relative to its industry.

Is Art's-Way Manufacturing Making Efficient Use Of Its Profits?

Given that Art's-Way Manufacturing doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.

Summary

On the whole, we do feel that Art's-Way Manufacturing has some positive attributes. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 4 risks we have identified for Art's-Way Manufacturing by visiting our risks dashboard for free on our platform here.

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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.