Avient Corporation's (NYSE:AVNT) Stock's Been Going Strong: Could Weak Financials Mean The Market Will Correct Its Share Price?

Avient's (NYSE:AVNT) stock is up by a considerable 11% over the past three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Specifically, we decided to study Avient'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Avient

How To 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 Avient is:

1.4% = US$32m ÷ US$2.3b (Based on the trailing twelve months to September 2023).

The 'return' refers to a company's earnings over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.01.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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 Avient's Earnings Growth And 1.4% ROE

It is hard to argue that Avient's ROE is much good in and of itself. Even when compared to the industry average of 14%, the ROE figure is pretty disappointing. Hence, the flat earnings seen by Avient over the past five years could probably be the result of it having a lower ROE.

We then compared Avient's net income growth with the industry and found that the average industry growth rate was 13% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for AVNT? You can find out in our latest intrinsic value infographic research report.

Is Avient Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 60% (meaning, the company retains only 40% of profits) for Avient suggests that the company's earnings growth was miniscule as a result of paying out a majority of its earnings.

In addition, Avient has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 34% over the next three years. The fact that the company's ROE is expected to rise to 9.8% over the same period is explained by the drop in the payout ratio.

Conclusion

Overall, we would be extremely cautious before making any decision on Avient. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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. 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.