Should Weakness in Afluente Transmissão de Energia Elétrica S.A.'s (BVMF:AFLT3) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

It is hard to get excited after looking at Afluente Transmissão de Energia Elétrica's (BVMF:AFLT3) recent performance, when its stock has declined 1.4% over the past week. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on Afluente Transmissão de Energia Elétrica'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.

Check out our latest analysis for Afluente Transmissão de Energia Elétrica

How Is ROE Calculated?

Return on equity can be calculated by using the formula:

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

So, based on the above formula, the ROE for Afluente Transmissão de Energia Elétrica is:

12% = R$22m ÷ R$187m (Based on the trailing twelve months to September 2020).

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$0.12 in profit.

Why Is ROE Important For 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Afluente Transmissão de Energia Elétrica's Earnings Growth And 12% ROE

It is hard to argue that Afluente Transmissão de Energia Elétrica's ROE is much good in and of itself. Even compared to the average industry ROE of 16%, the company's ROE is quite dismal. However, the moderate 17% net income growth seen by Afluente Transmissão de Energia Elétrica over the past five years is definitely a positive. We reckon that there could be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Afluente Transmissão de Energia Elétrica's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 16% in the same period.

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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Afluente Transmissão de Energia Elétrica's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Afluente Transmissão de Energia Elétrica Using Its Retained Earnings Effectively?

With a three-year median payout ratio of 32% (implying that the company retains 68% of its profits), it seems that Afluente Transmissão de Energia Elétrica is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Besides, Afluente Transmissão de Energia Elétrica has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.

Summary

Overall, we feel that Afluente Transmissão de Energia Elétrica certainly does have some positive factors to consider. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. 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. To know the 1 risk we have identified for Afluente Transmissão de Energia Elétrica visit our risks dashboard for free.

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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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