Should Weakness in Peab AB (publ)'s (STO:PEAB B) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

With its stock down 4.2% over the past week, it is easy to disregard Peab (STO:PEAB B). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Peab's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Peab

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 Peab is:

14% = kr2.4b ÷ kr17b (Based on the trailing twelve months to December 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each SEK1 of shareholders' capital it has, the company made SEK0.14 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. 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 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.

Peab's Earnings Growth And 14% ROE

To begin with, Peab seems to have a respectable ROE. On comparing with the average industry ROE of 8.9% the company's ROE looks pretty remarkable. For this reason, Peab's five year net income decline of 6.8% raises the question as to why the high ROE didn't translate into earnings growth. We reckon that there could be some other factors at play here that are preventing the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

So, as a next step, we compared Peab's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 6.3% over the last few years.

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. This then helps them determine if the stock is placed for a bright or bleak future. Is Peab fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Peab Using Its Retained Earnings Effectively?

Looking at its three-year median payout ratio of 49% (or a retention ratio of 51%) which is pretty normal, Peab's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

In addition, Peab has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 52%. As a result, Peab's ROE is not expected to change by much either, which we inferred from the analyst estimate of 12% for future ROE.

Conclusion

In total, it does look like Peab has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.