Should Weakness in ABM International Limited's (NSE:ABMINTLTD) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

It is hard to get excited after looking at ABM International's (NSE:ABMINTLTD) recent performance, when its stock has declined 9.2% over the past three months. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on ABM International's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for ABM International

How To Calculate Return On Equity?

Return on equity 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 ABM International is:

38% = ₹51m ÷ ₹135m (Based on the trailing twelve months to December 2020).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.38 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

A Side By Side comparison of ABM International's Earnings Growth And 38% ROE

First thing first, we like that ABM International has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 4.1% also doesn't go unnoticed by us. Needless to say, we are quite surprised to see that ABM International's net income shrunk at a rate of 36% over the past five years. So, there might be some other aspects that could explain this. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

That being said, we compared ABM International's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 19% 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 ABM International is trading on a high P/E or a low P/E, relative to its industry.

Is ABM International Making Efficient Use Of Its Profits?

ABM International doesn't pay any dividend, meaning that the company is keeping all of its profits, which makes us wonder why it is retaining its earnings if it can't use them to grow its business. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Summary

In total, it does look like ABM International has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 2 risks we have identified for ABM International visit our risks dashboard for free.

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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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