Are Robust Financials Driving The Recent Rally In Atlas Copco AB's (STO:ATCO A) Stock?

Most readers would already be aware that Atlas Copco's (STO:ATCO A) stock increased significantly by 11% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Atlas Copco's ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Atlas Copco

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 Atlas Copco is:

31% = kr28b ÷ kr92b (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. Another way to think of that is that for every SEK1 worth of equity, the company was able to earn SEK0.31 in profit.

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.

Atlas Copco's Earnings Growth And 31% ROE

Firstly, we acknowledge that Atlas Copco has a significantly high ROE. Secondly, even when compared to the industry average of 16% the company's ROE is quite impressive. This probably laid the groundwork for Atlas Copco's moderate 12% net income growth seen over the past five years.

We then performed a comparison between Atlas Copco's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 11% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Atlas Copco is trading on a high P/E or a low P/E, relative to its industry.

Is Atlas Copco Efficiently Re-investing Its Profits?

With a three-year median payout ratio of 48% (implying that the company retains 52% of its profits), it seems that Atlas Copco is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Additionally, Atlas Copco has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 49% of its profits over the next three years. Accordingly, forecasts suggest that Atlas Copco's future ROE will be 26% which is again, similar to the current ROE.

Conclusion

In total, we are pretty happy with Atlas Copco's 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 substantial growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.