Is Weakness In AQT Water S.A. (WSE:AQT) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

With its stock down 60% over the past three months, it is easy to disregard AQT Water (WSE:AQT). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on AQT Water'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for AQT Water

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 AQT Water is:

61% = zł1.7m ÷ zł2.8m (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. That means that for every PLN1 worth of shareholders' equity, the company generated PLN0.61 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

A Side By Side comparison of AQT Water's Earnings Growth And 61% ROE

Firstly, we acknowledge that AQT Water has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 8.8% which is quite remarkable. Under the circumstances, AQT Water's considerable five year net income growth of 48% was to be expected.

Next, on comparing with the industry net income growth, we found that AQT Water's growth is quite high when compared to the industry average growth of 38% in the same period, which is great to see.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 AQT Water is trading on a high P/E or a low P/E, relative to its industry.

Is AQT Water Efficiently Re-investing Its Profits?

Conclusion

On the whole, we feel that AQT Water's performance has been quite good. 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 substantial growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. You can see the 3 risks we have identified for AQT Water by visiting our risks dashboard for free on our platform here.

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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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