Is Ambev S.A.'s (BVMF:ABEV3) Stock Price Struggling As A Result Of Its Mixed Financials?

Ambev (BVMF:ABEV3) has had a rough three months with its share price down 3.0%. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Particularly, we will be paying attention to Ambev's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See 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:

16% = R$12b ÷ R$75b (Based on the trailing twelve months to December 2020).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every R$1 of its shareholder's investments, the company generates a profit of R$0.16.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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 16% ROE

On the face of it, Ambev's ROE is not much to talk about. Although a closer study shows that the company's ROE is higher than the industry average of 12% which we definitely can't overlook. But then again, seeing that Ambev's net income shrunk at a rate of 3.6% in the past five years, makes us think again. Remember, the company's ROE is a bit low to begin with, just that it is higher than the industry average. So that could be one of the factors that are causing earnings growth to shrink.

However, when we compared Ambev's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 5.5% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One 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 prospects. So, you may want to check if Ambev is trading on a high P/E or a low P/E, relative to its industry.

Is Ambev Using Its Retained Earnings Effectively?

Ambev's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 76% (or a retention ratio of 24%). With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 2 risks we have identified for Ambev by visiting our risks dashboard for free on our platform here.

In addition, Ambev has been paying dividends over a period of seven years suggesting that keeping up dividend payments is preferred by the management even though earnings have been in decline. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 85%. Accordingly, forecasts suggest that Ambev's future ROE will be 18% which is again, similar to the current ROE.

Summary

In total, we're a bit ambivalent about Ambev's performance. Primarily, we are disappointed to see a lack of growth in earnings even in spite of a moderate ROE. Bear in mind, the company reinvests a small portion of its profits, which explains the lack of growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings 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. 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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