Are Aeris Environmental Ltd's (ASX:AEI) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

Aeris Environmental (ASX:AEI) has had a rough three months with its share price down 45%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Aeris Environmental's 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.

See our latest analysis for Aeris Environmental

How Do You Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Aeris Environmental is:

10% = AU$2.0m ÷ AU$19m (Based on the trailing twelve months to June 2020).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.10 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Aeris Environmental's Earnings Growth And 10% ROE

To start with, Aeris Environmental's ROE looks acceptable. Even so, when compared with the average industry ROE of 14%, we aren't very excited. On further research, we found that Aeris Environmental's net income growth of 2.9% over the past five years is quite low. Bear in mind, the company does have a respectable level of ROE. It is just that the industry ROE is higher. So there might be other reasons for the earnings growth to be low. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

Next, on comparing with the industry net income growth, we found that Aeris Environmental's reported growth was lower than the industry growth of 4.5% in the same period, which is not something we like to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Aeris Environmental's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Aeris Environmental Making Efficient Use Of Its Profits?

Summary

On the whole, we do feel that Aeris Environmental has some positive attributes. However, while the company does have a decent ROE and a high profit retention, its earnings growth number is quite disappointing. This suggests that there might be some external threat to the business, that's hampering 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. Our risks dashboard would have the 4 risks we have identified for Aeris Environmental.

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This article by Simply Wall St is general in nature. 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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