Evolution AB (publ)'s (STO:EVO) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

Evolution (STO:EVO) has had a rough month with its share price down 2.6%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Evolution'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

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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 Evolution is:

31% = €1.2b ÷ €4.0b (Based on the trailing twelve months to December 2024).

The 'return' is the income the business earned over the last year. That means that for every SEK1 worth of shareholders' equity, the company generated SEK0.31 in profit.

See our latest analysis for Evolution

What Has ROE Got To Do With 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. 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.

Evolution's Earnings Growth And 31% ROE

First thing first, we like that Evolution has an impressive ROE. Secondly, even when compared to the industry average of 25% the company's ROE is quite impressive. As a result, Evolution's exceptional 33% net income growth seen over the past five years, doesn't come as a surprise.

As a next step, we compared Evolution's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 19%.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Evolution is trading on a high P/E or a low P/E, relative to its industry.

Is Evolution Using Its Retained Earnings Effectively?

The three-year median payout ratio for Evolution is 48%, which is moderately low. The company is retaining the remaining 52%. By the looks of it, the dividend is well covered and Evolution is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Besides, Evolution has been paying dividends over a period of nine years. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 50% of its profits over the next three years. Accordingly, forecasts suggest that Evolution's future ROE will be 31% which is again, similar to the current ROE.

Conclusion

Overall, we are quite pleased with Evolution's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.