Evolution AB (publ)'s (STO:EVO) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

With its stock down 11% over the past three months, it is easy to disregard Evolution (STO:EVO). 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. Specifically, we decided to study Evolution's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Evolution

How Is ROE Calculated?

The formula for return on equity is:

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

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

30% = €1.1b ÷ €3.7b (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. So, this means that for every SEK1 of its shareholder's investments, the company generates a profit of SEK0.30.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

A Side By Side comparison of Evolution's Earnings Growth And 30% ROE

First thing first, we like that Evolution has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 24% also doesn't go unnoticed by us. So, the substantial 38% net income growth seen by Evolution over the past five years isn't overly surprising.

We then compared Evolution's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 14% 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. This then helps them determine if the stock is placed for a bright or bleak future. 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 Efficiently Re-investing Its Profits?

Evolution's three-year median payout ratio is a pretty moderate 45%, meaning the company retains 55% of its income. 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 eight years. 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 51%. As a result, Evolution's ROE is not expected to change by much either, which we inferred from the analyst estimate of 30% for future ROE.

Summary

In total, we are pretty happy 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. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.