Most readers would already be aware that Axfood's (STO:AXFO) stock increased significantly by 12% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. 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.
How Do You Calculate Return On Equity?
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:
55% = kr1.9b ÷ kr3.5b (Based on the trailing twelve months to March 2021).
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 SEK0.55 in profit.
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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.
A Side By Side comparison of Axfood's Earnings Growth And 55% ROE
Firstly, we acknowledge that Axfood has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 10% which is quite remarkable. Probably as a result of this, Axfood was able to see a decent net income growth of 5.6% over the last 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 6.9% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. What is AXFO worth today? The intrinsic value infographic in our free research report helps visualize whether AXFO is currently mispriced by the market.
Is Axfood Efficiently Re-investing Its Profits?
While Axfood has a three-year median payout ratio of 92% (which means it retains 7.9% 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.
Besides, Axfood has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 81%. Regardless, Axfood's ROE is speculated to decline to 39% despite there being no anticipated change in its payout ratio.
On the whole, we do feel that Axfood has some positive attributes. Especially the growth in earnings which was backed by an impressive ROE. Still, the high ROE could have been even more beneficial to investors had the company been reinvesting more of its profits. As highlighted earlier, the current reinvestment rate appears to be negligible. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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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