Declining Stock and Decent Financials: Is The Market Wrong About AO World plc (LON:AO.)?

AO World (LON:AO.) has had a rough week with its share price down 8.1%. 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. Particularly, we will be paying attention to AO World's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for AO World

How To 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 AO World is:

6.1% = UK£6.4m ÷ UK£106m (Based on the trailing twelve months to March 2023).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.06 in profit.

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.

AO World's Earnings Growth And 6.1% ROE

On the face of it, AO World'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 14% either. However, the moderate 10% net income growth seen by AO World over the past five years is definitely a positive. We reckon that there could be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared AO World's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 15% in the same period.

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. What is AO. worth today? The intrinsic value infographic in our free research report helps visualize whether AO. is currently mispriced by the market.

Is AO World Making Efficient Use Of Its Profits?

AO World doesn't pay any dividend, meaning that all of its profits are being reinvested in the business, which explains the fair bit of earnings growth the company has seen.

Conclusion

On the whole, we do feel that AO World 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. 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.