Is Weakness In ABB Ltd (VTX:ABBN) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

With its stock down 16% over the past three months, it is easy to disregard ABB (VTX:ABBN). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to ABB's ROE today.

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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

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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 ABB is:

26% = US$4.0b ÷ US$15b (Based on the trailing twelve months to December 2024).

The 'return' is the yearly profit. That means that for every CHF1 worth of shareholders' equity, the company generated CHF0.26 in profit.

See our latest analysis for ABB

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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.

ABB's Earnings Growth And 26% ROE

To begin with, ABB has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 19% the company's ROE is quite impressive. So, the substantial 27% 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.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. What is ABBN worth today? The intrinsic value infographic in our free research report helps visualize whether ABBN is currently mispriced by the market.

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. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 38% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.

Conclusion

Overall, we are quite pleased with ABB's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial 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. 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.