Are AF Gruppen ASA's (OB:AFG) Mixed Financials Driving The Negative Sentiment?

It is hard to get excited after looking at AF Gruppen's (OB:AFG) recent performance, when its stock has declined 10% over the past three months. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. In this article, we decided to focus on AF Gruppen's ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for AF Gruppen

How To 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 AF Gruppen is:

20% = kr647m ÷ kr3.3b (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each NOK1 of shareholders' capital it has, the company made NOK0.20 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. 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.

AF Gruppen's Earnings Growth And 20% ROE

At first glance, AF Gruppen seems to have a decent ROE. On comparing with the average industry ROE of 14% the company's ROE looks pretty remarkable. Needless to say, we are quite surprised to see that AF Gruppen's net income shrunk at a rate of 5.0% over the past five years. 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.

That being said, we compared AF Gruppen'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 16% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. 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 Making Efficient Use Of Its Profits?

With a three-year median payout ratio as high as 107%,AF Gruppen's shrinking earnings don't come as a surprise as the company is paying a dividend which is beyond its means. Paying a dividend beyond their means is usually not viable over the long term.

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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 92%. Still, forecasts suggest that AF Gruppen's future ROE will rise to 26% even though the the company's payout ratio is not expected to change by much.

Summary

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. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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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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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com