AF Gruppen ASA's (OB:AFG) Financials Are Too Obscure To Link With Current Share Price Momentum: What's In Store For the Stock?

AF Gruppen (OB:AFG) has had a great run on the share market with its stock up by a significant 16% over the last three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. In this article, we decided to focus on AF Gruppen's ROE.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for AF Gruppen

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for AF Gruppen is:

19% = kr578m ÷ kr3.1b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. So, this means that for every NOK1 of its shareholder's investments, the company generates a profit of NOK0.19.

Why Is ROE Important For 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 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.

A Side By Side comparison of AF Gruppen's Earnings Growth And 19% ROE

To start with, AF Gruppen's ROE looks acceptable. Further, the company's ROE is similar to the industry average of 16%. As you might expect, the 11% net income decline reported by AF Gruppen is a bit of a surprise. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

However, when we compared AF Gruppen's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 6.2% in the same period. This is quite worrisome.

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. If you're wondering about AF Gruppen's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is AF Gruppen Using Its Retained Earnings Effectively?

AF Gruppen's very high three-year median payout ratio of 107% over the last three years suggests that the company is paying its shareholders more than what it is earning and this explains the company's shrinking earnings. Paying a dividend higher than reported profits is not a sustainable move.

Moreover, AF Gruppen has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 85% over the next three years.

Conclusion

In total, we're a bit ambivalent about AF Gruppen's performance. While the company does have a high rate of return, its low earnings retention is probably what's hampering its earnings growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.