Could The Market Be Wrong About Axfood AB (publ) (STO:AXFO) Given Its Attractive Financial Prospects?

With its stock down 16% over the past month, it is easy to disregard Axfood (STO:AXFO). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Axfood's ROE today.

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 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 Axfood

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 Axfood is:

34% = kr2.4b ÷ kr7.0b (Based on the trailing twelve months to September 2024).

The 'return' is the profit over the last twelve months. So, this means that for every SEK1 of its shareholder's investments, the company generates a profit of SEK0.34.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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.

Axfood's Earnings Growth And 34% ROE

First thing first, we like that Axfood has an impressive ROE. Additionally, the company's ROE is higher compared to the industry average of 12% which is quite remarkable. This probably laid the groundwork for Axfood's moderate 7.7% net income growth seen over the past five years.

We then performed a comparison between Axfood's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 8.7% in the same 5-year period.

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. Doing so will help them establish if the stock's future looks promising or ominous. Is Axfood fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Axfood Using Its Retained Earnings Effectively?

While Axfood has a three-year median payout ratio of 77% (which means it retains 23% 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.

Additionally, Axfood 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 70%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 33%.

Conclusion

On the whole, we feel that Axfood's performance has been quite good. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.

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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.