Avast's (LON:AVST) stock is up by a considerable 7.3% over the past month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Avast's ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.
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 Avast is:
14% = US$170m ÷ US$1.2b (Based on the trailing twelve months to December 2020).
The 'return' refers to a company's earnings over the last year. That means that for every £1 worth of shareholders' equity, the company generated £0.14 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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. 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.
Avast's Earnings Growth And 14% ROE
To begin with, Avast seems to have a respectable ROE. Even when compared to the industry average of 13% the company's ROE looks quite decent. This probably goes some way in explaining Avast's significant 26% net income growth over the past five years amongst other factors. We reckon that there could also be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.
Next, on comparing with the industry net income growth, we found that Avast's growth is quite high when compared to the industry average growth of 13% in the same period, which is great to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. What is AVST worth today? The intrinsic value infographic in our free research report helps visualize whether AVST is currently mispriced by the market.
Is Avast Using Its Retained Earnings Effectively?
Avast has a significant three-year median payout ratio of 64%, meaning the company only retains 36% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.
Along with seeing a growth in earnings, Avast only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 46% over the next three years. As a result, the expected drop in Avast's payout ratio explains the anticipated rise in the company's future ROE to 26%, over the same period.
On the whole, we feel that Avast's performance has been quite good. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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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