Declining Stock and Solid Fundamentals: Is The Market Wrong About Afya Limited (NASDAQ:AFYA)?

It is hard to get excited after looking at Afya's (NASDAQ:AFYA) recent performance, when its stock has declined 4.6% over the past week. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Afya's ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

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How Do You Calculate Return On Equity?

ROE 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 Afya is:

16% = R$698m ÷ R$4.4b (Based on the trailing twelve months to March 2025).

The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.16.

View our latest analysis for Afya

Why Is ROE Important For 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of Afya's Earnings Growth And 16% ROE

To start with, Afya's ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 15%. Consequently, this likely laid the ground for the impressive net income growth of 21% seen over the past five years by Afya. We reckon that there could also be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Afya's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 26% 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. 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 Afya is trading on a high P/E or a low P/E, relative to its industry.

Is Afya Efficiently Re-investing Its Profits?

Afya has a really low three-year median payout ratio of 19%, meaning that it has the remaining 81% left over to reinvest into its business. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Our latest analyst data shows that the future payout ratio of the company is expected to drop to 14% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 20%, over the same period.

Summary

In total, we are pretty happy with Afya'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. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.