Most readers would already be aware that Ambev's (BVMF:ABEV3) stock increased significantly by 7.3% over the past month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Ambev'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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out the opportunities and risks within the XX Beverage industry.
How To 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 Ambev is:
15% = R$14b ÷ R$92b (Based on the trailing twelve months to September 2022).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each R$1 of shareholders' capital it has, the company made R$0.15 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.
A Side By Side comparison of Ambev's Earnings Growth And 15% ROE
On the face of it, Ambev's ROE is not much to talk about. However, given that the company's ROE is similar to the average industry ROE of 12%, we may spare it some thought. Having said that, Ambev has shown a modest net income growth of 11% over the past five years. Considering the moderately low ROE, it is quite possible that there might be some 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 Ambev's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 7.5%.
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). Doing so will help them establish if the stock's future looks promising or ominous. Is ABEV3 fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Ambev Using Its Retained Earnings Effectively?
While Ambev has a three-year median payout ratio of 70% (which means it retains 30% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.
Moreover, Ambev is determined to keep sharing its profits with shareholders which we infer from its long history of nine years of paying a dividend. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 88% over the next three years. However, Ambev's future ROE is expected to rise to 20% despite the expected increase in the company's payout ratio. We infer that there could be other factors that could be driving the anticipated growth in the company's ROE.
Overall, we feel that Ambev certainly does have some positive factors to consider. While no doubt its earnings growth is pretty substantial, we do feel that the reinvestment rate is pretty low, meaning, the earnings growth number could have been significantly higher had the company been retaining more of its profits. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. 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.
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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.