Will Weakness in Atlas Copco AB (publ)'s (STO:ATCO A) Stock Prove Temporary Given Strong Fundamentals?

With its stock down 14% over the past three months, it is easy to disregard Atlas Copco (STO:ATCO A). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Atlas Copco's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See 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:

28% = kr29b ÷ kr102b (Based on the trailing twelve months to September 2024).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every SEK1 worth of equity, the company was able to earn SEK0.28 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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 Atlas Copco's Earnings Growth And 28% ROE

To begin with, Atlas Copco has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 15% the company's ROE is quite impressive. This probably laid the groundwork for Atlas Copco's moderate 15% 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 13% 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. Is ATCO A fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Atlas Copco Efficiently Re-investing Its Profits?

Atlas Copco has a three-year median payout ratio of 47%, which implies that it retains the remaining 53% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

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 25% which is again, similar to the current ROE.

Summary

In total, we are pretty happy with Atlas Copco's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable 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.