Are AB Dynamics plc's (LON:ABDP) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

It is hard to get excited after looking at AB Dynamics' (LON:ABDP) recent performance, when its stock has declined 6.3% over the past month. 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. Specifically, we decided to study AB Dynamics' ROE in this article.

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.

Check out our latest analysis for AB Dynamics

How Is ROE Calculated?

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 AB Dynamics is:

2.8% = UK£2.9m ÷ UK£103m (Based on the trailing twelve months to February 2021).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.03 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 AB Dynamics' Earnings Growth And 2.8% ROE

It is quite clear that AB Dynamics' ROE is rather low. Even when compared to the industry average of 8.4%, the ROE figure is pretty disappointing. Although, we can see that AB Dynamics saw a modest net income growth of 8.4% over the past five years. We reckon that there could be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

We then compared AB Dynamics' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 35% in the same period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is AB Dynamics fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is AB Dynamics Using Its Retained Earnings Effectively?

In AB Dynamics' case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 10% (or a retention ratio of 90%), which suggests that the company is investing most of its profits to grow its business.

Besides, AB Dynamics has been paying dividends over a period of seven years. This shows that the company is committed to sharing profits with its shareholders. 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 8.8%.

Summary

On the whole, we do feel that AB Dynamics has some positive attributes. Specifically, its fairly high earnings growth number, which no doubt was backed by the company's high earnings retention. Still, the low ROE means that all that reinvestment is not reaping a lot of benefit to the investors. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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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