Most readers would already be aware that Airtel Africa's (LON:AAF) stock increased significantly by 5.1% over the past month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on Airtel Africa's ROE.
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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Do You Calculate Return On Equity?
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 Airtel Africa is:
10% = US$333m ÷ US$3.3b (Based on the trailing twelve months to June 2020).
The 'return' is the amount earned after tax over the last twelve months. That means that for every £1 worth of shareholders' equity, the company generated £0.10 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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 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.
Airtel Africa's Earnings Growth And 10% ROE
At first glance, Airtel Africa seems to have a decent ROE. Even when compared to the industry average of 9.0% the company's ROE looks quite decent. This probably goes some way in explaining Airtel Africa's significant 82% net income growth over the past five years amongst other factors. However, there could also be other drivers behind this growth. 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.
As a next step, we compared Airtel Africa's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 6.1%.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Airtel Africa is trading on a high P/E or a low P/E, relative to its industry.
Is Airtel Africa Making Efficient Use Of Its Profits?
Airtel Africa has a significant three-year median payout ratio of 58%, meaning the company only retains 42% 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, Airtel Africa only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 80% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.
In total, we are pretty happy with Airtel Africa's performance. 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. 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. 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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