Infrea AB (STO:INFREA) Is Going Strong But Fundamentals Appear To Be Mixed : Is There A Clear Direction For The Stock?

Infrea's (STO:INFREA) stock is up by a considerable 5.9% over the past month. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on Infrea's ROE.

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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Infrea

How Is ROE Calculated?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Infrea is:

2.1% = kr7.1m ÷ kr345m (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. So, this means that for every SEK1 of its shareholder's investments, the company generates a profit of SEK0.02.

Why Is ROE Important For 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 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 Infrea's Earnings Growth And 2.1% ROE

It is quite clear that Infrea's ROE is rather low. Even compared to the average industry ROE of 18%, the company's ROE is quite dismal. For this reason, Infrea's five year net income decline of 34% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

That being said, we compared Infrea's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 10% in the same period.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Infrea's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Infrea Using Its Retained Earnings Effectively?

Infrea's low LTM (or last twelve month) payout ratio of 24% (implying that it retains the remaining 76% of its profits) comes as a surprise when you pair it with the shrinking earnings. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, Infrea only recently started paying a dividend so the management probably decided the shareholders prefer dividends even though earnings have been shrinking.

Conclusion

In total, we're a bit ambivalent about Infrea's performance. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. You can see the 4 risks we have identified for Infrea 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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