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

AAK AB (publ.) (STO:AAK) has had a rough month with its share price down 4.9%. 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 AAK AB (publ.)'s ROE.

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

See our latest analysis for AAK AB (publ.)

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for AAK AB (publ.) is:

15% = kr1.5b ÷ kr10b (Based on the trailing twelve months to June 2020).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every SEK1 of its shareholder's investments, the company generates a profit of SEK0.15.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

AAK AB (publ.)'s Earnings Growth And 15% ROE

To begin with, AAK AB (publ.) seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 8.1%. This probably laid the ground for AAK AB (publ.)'s moderate 11% net income growth seen over the past five years.

Next, on comparing with the industry net income growth, we found that AAK AB (publ.)'s growth is quite high when compared to the industry average growth of 8.4% in the same period, which is great to see.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 AAK AB (publ.) is trading on a high P/E or a low P/E, relative to its industry.

Is AAK AB (publ.) Efficiently Re-investing Its Profits?

While the company did pay out a portion of its dividend in the past, it currently doesn't pay a dividend. We infer that the company has been reinvesting all of its profits to grow its business.

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 36%. Accordingly, forecasts suggest that AAK AB (publ.)'s future ROE will be 14% which is again, similar to the current ROE.

Conclusion

On the whole, we feel that AAK AB (publ.)'s performance has been quite good. 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. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. 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. 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.
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