AvalonBay Communities, Inc. (NYSE:AVB) Is Going Strong But Fundamentals Appear To Be Mixed : Is There A Clear Direction For The Stock?
AvalonBay Communities (NYSE:AVB) has had a great run on the share market with its stock up by a significant 6.2% over the last week. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study AvalonBay Communities' ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
See our latest analysis for AvalonBay Communities
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 AvalonBay Communities is:
7.2% = US$786m ÷ US$11b (Based on the trailing twelve months to June 2020).
The 'return' is the income the business earned over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.07 in profit.
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 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 AvalonBay Communities' Earnings Growth And 7.2% ROE
At first glance, AvalonBay Communities' ROE doesn't look very promising. Although a closer study shows that the company's ROE is higher than the industry average of 5.0% which we definitely can't overlook. Having said that, AvalonBay Communities' net income growth over the past five years is more or less flat. Bear in mind, the company does have a slightly low ROE. It is just that the industry ROE is lower. So that could be one of the factors that are causing earnings growth to stay flat.
We then compared AvalonBay Communities' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 14% in the same period, which is a bit concerning.
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 AVB fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is AvalonBay Communities Efficiently Re-investing Its Profits?
AvalonBay Communities seems to be paying out most of its income as dividends judging by its three-year median payout ratio of 66%, meaning that the company retains only 34% of its profits. However, this is typical for REITs as they are often required by law to distribute most of their earnings. So this probably explains the absence of growth in earnings.
Moreover, AvalonBay Communities has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 69% of its profits over the next three years. Accordingly, forecasts suggest that AvalonBay Communities' future ROE will be 6.8% which is again, similar to the current ROE.
Summary
In total, we're a bit ambivalent about AvalonBay Communities' performance. Specifically, the low earnings growth is a bit concerning, especially given that the company has a respectable rate of return. Investors may have benefitted, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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