Are Afry AB's (STO:AFRY) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

It is hard to get excited after looking at Afry's (STO:AFRY) recent performance, when its stock has declined 16% over the past three months. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Afry's ROE.

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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Afry

How Is ROE Calculated?

Return on equity can be calculated by using the formula:

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

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

9.7% = kr1.2b ÷ kr13b (Based on the trailing twelve months to June 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 SEK0.10 in profit.

Why Is ROE Important For 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Afry's Earnings Growth And 9.7% ROE

To start with, Afry's ROE looks acceptable. Be that as it may, the company's ROE is still quite lower than the industry average of 16%. However, the moderate 6.7% net income growth seen by Afry over the past five years is definitely a positive. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place. Bear in mind, the company does have a respectable level of ROE. It is just that the industry ROE is higher. So this also does lend some color to the fairly high earnings growth seen by the company.

We then compared Afry's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 14% in the same 5-year period, which is a bit concerning.

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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Afry's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Afry Making Efficient Use Of Its Profits?

While Afry has a three-year median payout ratio of 59% (which means it retains 41% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.

Moreover, Afry is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 50%. Regardless, the future ROE for Afry is predicted to rise to 12% despite there being not much change expected in its payout ratio.

Summary

On the whole, we do feel that Afry has some positive attributes. Its earnings have grown respectably as we saw earlier, which was likely achieved by the company reinvesting its earnings at a decent rate of return. Still, its earnings retention is quite low, so we wonder if the company's growth could be higher, were it to pay out less dividends and retain more of its profits? Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.