ABB Ltd (VTX:ABBN) Stock Has Shown Weakness Lately But Financials Look Strong: Should Prospective Shareholders Make The Leap?

ABB (VTX:ABBN) has had a rough week with its share price down 5.3%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on ABB's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for ABB

How To Calculate Return On Equity?

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 ABB is:

26% = US$3.9b ÷ US$15b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. So, this means that for every CHF1 of its shareholder's investments, the company generates a profit of CHF0.26.

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 ABB's Earnings Growth And 26% ROE

First thing first, we like that ABB has an impressive ROE. Secondly, even when compared to the industry average of 19% the company's ROE is quite impressive. So, the substantial 30% net income growth seen by ABB over the past five years isn't overly surprising.

Next, on comparing with the industry net income growth, we found that ABB's growth is quite high when compared to the industry average growth of 20% in the same period, which is great to see.

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). 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 ABB is trading on a high P/E or a low P/E, relative to its industry.

Is ABB Using Its Retained Earnings Effectively?

ABB has a three-year median payout ratio of 49% (where it is retaining 51% of its income) which is not too low or not too high. By the looks of it, the dividend is well covered and ABB is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Additionally, ABB has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 49% of its profits over the next three years. Accordingly, forecasts suggest that ABB's future ROE will be 24% which is again, similar to the current ROE.

Conclusion

On the whole, we feel that ABB's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.