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Declining Stock and Decent Financials: Is The Market Wrong About Aeris Environmental Ltd (ASX:AEI)?

Simply Wall St

Aeris Environmental (ASX:AEI) has had a rough month with its share price down 5.4%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Aeris Environmental's ROE today.

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. 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 Aeris Environmental

How Is ROE Calculated?

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 Aeris Environmental is:

10% = AU$2.0m ÷ AU$19m (Based on the trailing twelve months to June 2020).

The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.10 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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 Aeris Environmental's Earnings Growth And 10% ROE

To begin with, Aeris Environmental seems to have a respectable ROE. Even so, when compared with the average industry ROE of 15%, we aren't very excited. Further, Aeris Environmental's five year net income growth of 2.9% is on the lower side. Bear in mind, the company does have a respectable level of ROE. It is just that the industry ROE is higher. So there might be other reasons for the earnings growth to be low. These include low earnings retention or poor capital allocation.

We then compared Aeris Environmental's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 25% in the same period, which is a bit concerning.

past-earnings-growth
past-earnings-growth

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is Aeris Environmental fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Aeris Environmental Efficiently Re-investing Its Profits?

Aeris Environmental doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. However, this doesn't explain the low earnings growth the company has seen. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Conclusion

Overall, we feel that Aeris Environmental certainly does have some positive factors to consider. However, while the company does have a decent ROE and a high profit retention, its earnings growth number is quite disappointing. This suggests that there might be some external threat to the business, that's hampering growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard would have the 2 risks we have identified for Aeris Environmental.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.