Will Weakness in AAK AB (publ.)'s (STO:AAK) Stock Prove Temporary Given Strong Fundamentals?

It is hard to get excited after looking at AAK AB (publ.)'s (STO:AAK) recent performance, when its stock has declined 6.6% over the past three months. 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 AAK AB (publ.)'s ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for AAK AB (publ.)

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 AAK AB (publ.) is:

15% = kr1.5b ÷ kr11b (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every SEK1 worth of equity, the company was able to earn SEK0.15 in profit.

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. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of AAK AB (publ.)'s Earnings Growth And 15% ROE

At first glance, AAK AB (publ.) seems to have a decent ROE. On comparing with the average industry ROE of 12% the company's ROE looks pretty remarkable. Probably as a result of this, AAK AB (publ.) was able to see a decent growth of 11% over the last five years.

Next, on comparing AAK AB (publ.)'s net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 11% 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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is AAK fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is AAK AB (publ.) Making Efficient Use Of Its Profits?

AAK AB (publ.) has a three-year median payout ratio of 35%, which implies that it retains the remaining 65% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Additionally, AAK AB (publ.) 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. 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%. As a result, AAK AB (publ.)'s ROE is not expected to change by much either, which we inferred from the analyst estimate of 14% for future ROE.

Conclusion

Overall, we are quite pleased with AAK AB (publ.)'s performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. 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. 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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