Ambev S.A.'s (BVMF:ABEV3) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

It is hard to get excited after looking at Ambev's (BVMF:ABEV3) recent performance, when its stock has declined 19% over the past three months. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Ambev's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Ambev

How Do You Calculate Return On Equity?

The formula for ROE 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 yearly profit. One way to conceptualize this is that for each R$1 of shareholders' capital it has, the company made R$0.15 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.

Ambev's Earnings Growth And 15% ROE

On the face of it, Ambev's ROE is not much to talk about. However, its ROE is similar to the industry average of 12%, so we won't completely dismiss the company. 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.

Next, on comparing Ambev's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 9.3% in the same period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Making Efficient Use Of Its Profits?

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.

Additionally, Ambev has paid dividends over a period of nine 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 rise to 88% over the next three years. Still, forecasts suggest that Ambev's future ROE will rise to 19% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.

Summary

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. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.