Alfa Financial Software Holdings PLC's (LON:ALFA) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

With its stock down 8.2% over the past week, it is easy to disregard Alfa Financial Software Holdings (LON:ALFA). 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. Specifically, we decided to study Alfa Financial Software Holdings' 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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Alfa Financial Software Holdings

How Is ROE Calculated?

ROE can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Alfa Financial Software Holdings is:

56% = UK£24m ÷ UK£42m (Based on the trailing twelve months to December 2023).

The 'return' refers to a company's earnings over the last year. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.56.

What Has ROE Got To Do With 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Alfa Financial Software Holdings' Earnings Growth And 56% ROE

Firstly, we acknowledge that Alfa Financial Software Holdings has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 9.1% also doesn't go unnoticed by us. This likely paved the way for the modest 13% net income growth seen by Alfa Financial Software Holdings over the past five years.

We then compared Alfa Financial Software Holdings' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 19% in the same 5-year period, which is a bit concerning.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Alfa Financial Software Holdings fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Alfa Financial Software Holdings Making Efficient Use Of Its Profits?

Alfa Financial Software Holdings' three-year median payout ratio to shareholders is 15% (implying that it retains 85% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Moreover, Alfa Financial Software Holdings is determined to keep sharing its profits with shareholders which we infer from its long history of three years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 14%. Still, forecasts suggest that Alfa Financial Software Holdings' future ROE will drop to 31% even though the the company's payout ratio is not expected to change by much.

Summary

On the whole, we feel that Alfa Financial Software Holdings' performance has been quite good. 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 a good amount of 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. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.