It is hard to get excited after looking at AB Dynamics' (LON:ABDP) recent performance, when its stock has declined 14% 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. In this article, we decided to focus on AB Dynamics' ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Do You 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 AB Dynamics is:
2.8% = UK£2.9m ÷ UK£103m (Based on the trailing twelve months to February 2021).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.03 in profit.
What Is The Relationship Between ROE And Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
AB Dynamics' Earnings Growth And 2.8% ROE
As you can see, AB Dynamics' ROE looks pretty weak. Even when compared to the industry average of 9.8%, the ROE figure is pretty disappointing. However, the moderate 8.4% net income growth seen by AB Dynamics over the past five years is definitely a positive. We believe that 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 AB Dynamics' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 8.4% in the same period.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about AB Dynamics''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is AB Dynamics Making Efficient Use Of Its Profits?
AB Dynamics has a low three-year median payout ratio of 10%, meaning that the company retains the remaining 90% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.
Additionally, AB Dynamics has paid dividends over a period of seven years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 0.2% over the next three years.
Overall, we feel that AB Dynamics certainly does have some positive factors to consider. 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. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.
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.
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