Most readers would already be aware that ADVA Optical Networking's (ETR:ADV) stock increased significantly by 38% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to ADVA Optical Networking'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Do You Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for ADVA Optical Networking is:
7.7% = €20m ÷ €263m (Based on the trailing twelve months to December 2020).
The 'return' is the profit over the last twelve months. So, this means that for every €1 of its shareholder's investments, the company generates a profit of €0.08.
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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
ADVA Optical Networking's Earnings Growth And 7.7% ROE
On the face of it, ADVA Optical Networking's ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 10% either. Given the circumstances, the significant decline in net income by 23% seen by ADVA Optical Networking over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.
So, as a next step, we compared ADVA Optical Networking's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 24% 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. What is ADV worth today? The intrinsic value infographic in our free research report helps visualize whether ADV is currently mispriced by the market.
Is ADVA Optical Networking Making Efficient Use Of Its Profits?
On the whole, we feel that the performance shown by ADVA Optical Networking can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings 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. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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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