Associated British Foods plc's (LON:ABF) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

Most readers would already be aware that Associated British Foods' (LON:ABF) stock increased significantly by 16% 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. Specifically, we decided to study Associated British Foods' ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Associated British Foods

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 Associated British Foods is:

4.9% = UK£465m ÷ UK£9.4b (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.05.

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. 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.

Associated British Foods' Earnings Growth And 4.9% ROE

At first glance, Associated British Foods' ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 8.1% either. Hence, the flat earnings seen by Associated British Foods over the past five years could probably be the result of it having a lower ROE.

As a next step, we compared Associated British Foods' net income growth with the industry and discovered that the industry saw an average growth of 6.6% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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. Is ABF fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Associated British Foods Using Its Retained Earnings Effectively?

While the company did pay out a portion of its dividend in the past, it currently doesn't pay a dividend. We infer that the company has been reinvesting all of its profits to grow its business.

Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 35% of its profits over the next three years. Still, forecasts suggest that Associated British Foods' future ROE will rise to 11% even though the the company's payout ratio is not expected to change by much.

Conclusion

On the whole, we feel that the performance shown by Associated British Foods 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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