Do Its Financials Have Any Role To Play In Driving Associated British Foods plc's (LON:ABF) Stock Up Recently?
Most readers would already be aware that Associated British Foods' (LON:ABF) stock increased significantly by 15% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Associated British Foods' ROE.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. 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 Associated British Foods
How Is ROE Calculated?
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 Associated British Foods is:
9.5% = UK£1.1b ÷ UK£11b (Based on the trailing twelve months to September 2023).
The 'return' is the income the business earned over the last year. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.10.
What Is The Relationship Between ROE And 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 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.
Associated British Foods' Earnings Growth And 9.5% ROE
To start with, Associated British Foods' ROE looks acceptable. Further, the company's ROE is similar to the industry average of 9.2%. However, while Associated British Foods has a pretty respectable ROE, its five year net income decline rate was 2.4% . So, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.
However, when we compared Associated British Foods' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 3.9% in the same period. This is quite worrisome.
Earnings growth is a huge factor in stock valuation. 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. What is ABF worth today? The intrinsic value infographic in our free research report helps visualize whether ABF is currently mispriced by the market.
Is Associated British Foods Making Efficient Use Of Its Profits?
Despite having a normal three-year median payout ratio of 39% (where it is retaining 61% of its profits), Associated British Foods has seen a decline in earnings as we saw above. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
In addition, Associated British Foods 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 over the next three years is expected to be approximately 35%. Regardless, the future ROE for Associated British Foods is predicted to rise to 12% despite there being not much change expected in its payout ratio.
Conclusion
On the whole, we do feel that Associated British Foods has some positive attributes. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. 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.
