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When you look at the recent performance of Associated British Foods (LON: ABF), it’s hard to rejoice when its stock is down 15% over the past three months. It is possible that the markets have ignored the company’s disparate financials and decided to turn to negative sentiment. Long-term fundamentals usually drive market outcomes, so it is worth paying close attention to. In particular, we decided to investigate Associated British Foods’ ROE in this article.
Return on Equity, or ROE, is an important metric for assessing how efficiently a company’s management is using the company’s capital. In other words, it’s a profitability metric that measures the return on the capital provided by the company’s shareholders.
Check out our latest analysis for Associated British Foods
How is the ROE calculated?
The return on equity can be calculated using the following formula:
Return on Equity = Net Income (from continuing operations) ÷ Equity
So, based on the formula above, the ROE for Associated British Foods is:
4.3% = £ 416m ÷ £ 9.6b (based on the last 12 months ended February 2021).
The “return” is the profit for the past twelve months. One way to conceptualize this is that for every £ 1 of shareholder equity the company made a profit of £ 0.04.
Why is ROE important to earnings growth?
So far we have learned that ROE is a measure of a company’s profitability. Based on how much of its profits the company will reinvest or “keep”, we can then evaluate a company’s future ability to generate profits. Assuming all else is equal, companies that have both higher return on equity and higher earnings retention typically have a higher growth rate than companies that do not share the same characteristics.
Associated British Foods earnings growth and 4.3% ROE
At first glance, the Associated British Foods ROE doesn’t look that attractive. Another brief study shows that the company’s ROE is also not cheap compared to the industry average of 11%. Hence, it cannot be wrong to say that Associated British Foods’ 13% decline in net income over five years is likely due to a lower ROE. However, other factors can also cause the result to drop. For example – low profit retention or poor capital allocation.
As a next step, we compared Associated British Foods’ performance with the industry and were disappointed to find that while the company contracted profits, the industry rose 4.9% over the same period.
The basis for increasing the value of a company is largely linked to its earnings development. Next, investors need to determine whether or not expected earnings growth is already included in the stock price. That way, they can determine whether the future of the stock looks promising or ominous. A 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 outlook. Therefore, you should check to see if Associated British Foods is trading at high P / E or low P / E ratios compared to its industry.
Is Associated British Foods Using Its Profits Efficiently?
Despite a normal 3-year median payout ratio of 36% (with 64% of earnings withheld), Associated British Foods is seeing earnings decline, as we saw above. So other factors could play a role here that could potentially stifle growth. For example, the business has seen quite a bit of headwind.
Additionally, Associated British Foods has been paying dividends over a period of at least a decade, which means the company’s management is determined to pay dividends, even if it means little or no earnings growth. Our latest analyst data shows that the company’s future payout ratio is projected to be around 34% over the next three years. Regardless, the future ROE for Associated British Foods is expected to rise to 11%, although the payout ratio will not change materially.
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Overall, we are somewhat ambivalent about the performance of Associated British Foods. While the company has a high rate of retained earnings, its low rate of return is likely to be a drag on its earnings growth. The latest forecasts from industry analysts therefore show that analysts expect a huge improvement in the company’s earnings growth rate. To learn more about the latest analyst forecast for the company, check out this analyst forecast visualization for the company.
This article from Simply Wall St is of a general nature. We only provide comments based on historical data and analyst projections using an unbiased methodology, and our articles are not intended as financial advice. It is not a recommendation to buy or sell stocks and does not take into account your goals or your financial situation. Our goal is to provide you with long-term, focused analysis based on fundamentals. Note that our analysis may not take into account the latest company announcements or quality material, which may be sensitive to the price. Simply Wall St has no position in the stocks mentioned.
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