Declining Stock and Solid Fundamentals: Is The Market Wrong About AFT Pharmaceuticals Limited (NZSE:AFT)?

It is hard to get excited after looking at AFT Pharmaceuticals' (NZSE:AFT) recent performance, when its stock has declined 13% over the past week. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on AFT Pharmaceuticals' 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.

View our latest analysis for AFT Pharmaceuticals

How Is ROE Calculated?

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 AFT Pharmaceuticals is:

18% = NZ$16m ÷ NZ$88m (Based on the trailing twelve months to March 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every NZ$1 worth of equity, the company was able to earn NZ$0.18 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

AFT Pharmaceuticals' Earnings Growth And 18% ROE

To start with, AFT Pharmaceuticals' ROE looks acceptable. On comparing with the average industry ROE of 13% the company's ROE looks pretty remarkable. This certainly adds some context to AFT Pharmaceuticals' exceptional 20% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared AFT Pharmaceuticals' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 35% in the same period.

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 AFT Pharmaceuticals is trading on a high P/E or a low P/E, relative to its industry.

Is AFT Pharmaceuticals Using Its Retained Earnings Effectively?

AFT Pharmaceuticals has a really low three-year median payout ratio of 9.1%, meaning that it has the remaining 91% left over to reinvest into its business. So it looks like AFT Pharmaceuticals is reinvesting profits heavily to grow its business, which shows in its earnings growth.

While AFT Pharmaceuticals has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 15% over the next three years. Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.

Summary

Overall, we are quite pleased with AFT Pharmaceuticals' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see a good amount of growth in its earnings. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. 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.