Are Strong Financial Prospects The Force That Is Driving The Momentum In Avensia AB (publ)'s STO:AVEN) Stock?

Avensia (STO:AVEN) has had a great run on the share market with its stock up by a significant 38% over the last three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Avensia'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Avensia

How To Calculate Return On Equity?

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 Avensia is:

19% = kr13m ÷ kr70m (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. That means that for every SEK1 worth of shareholders' equity, the company generated SEK0.19 in profit.

What Has ROE Got To Do With 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.

A Side By Side comparison of Avensia's Earnings Growth And 19% ROE

To start with, Avensia's ROE looks acceptable. Especially when compared to the industry average of 15% the company's ROE looks pretty impressive. This probably laid the ground for Avensia's significant 22% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then performed a comparison between Avensia's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 20% in the same period.

Earnings growth is a huge factor in stock valuation. 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 Avensia fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Avensia Using Its Retained Earnings Effectively?

Avensia has a significant three-year median payout ratio of 65%, meaning the company only retains 35% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.

Besides, Avensia 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 54% of its profits over the next three years. Regardless, the future ROE for Avensia is predicted to rise to 37% despite there being not much change expected in its payout ratio.

Conclusion

Overall, we are quite pleased with Avensia's performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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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