Volvo Car AB (publ.)'s (STO:VOLCAR B) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

Volvo Car AB (publ.) (STO:VOLCAR B) has had a rough month with its share price down 20%. 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. Specifically, we decided to study Volvo Car AB (publ.)'s ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Volvo Car AB (publ.)

How Do You 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 Volvo Car AB (publ.) is:

8.9% = kr11b ÷ kr123b (Based on the trailing twelve months to June 2023).

The 'return' is the yearly profit. So, this means that for every SEK1 of its shareholder's investments, the company generates a profit of SEK0.09.

Why Is ROE Important For 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 Volvo Car AB (publ.)'s Earnings Growth And 8.9% ROE

To start with, Volvo Car AB (publ.)'s ROE looks acceptable. Even so, when compared with the average industry ROE of 16%, we aren't very excited. However, we are pleased to see the impressive 22% net income growth reported by Volvo Car AB (publ.) over the past five years. We believe that there might 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. Bear in mind, the company does have a respectable ROE. It is just that the industry ROE is higher. So this also does lend some color to the high earnings growth seen by the company.

We then compared Volvo Car AB (publ.)'s net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 15% in the same 5-year period.

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. 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 Volvo Car AB (publ.) is trading on a high P/E or a low P/E, relative to its industry.

Is Volvo Car AB (publ.) Making Efficient Use Of Its Profits?

While the company did pay out a portion of its dividend in the past, it currently doesn't pay a dividend. This is likely what's driving the high earnings growth number discussed above.

Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 27% over the next three years. Still, forecasts suggest that Volvo Car AB (publ.)'s future ROE will rise to 11% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.

Summary

Overall, we are quite pleased with Volvo Car AB (publ.)'s performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. The latest industry analyst forecasts show that the company is expected to maintain 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.