Autoliv’s (NYSE:ALV) stock is up by a considerable 11% over the past month. 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. Specifically, we decided to study Autoliv’s 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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company’s shareholders.
View our latest analysis for Autoliv
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 Autoliv is:
16% = US$425m ÷ US$2.6b (Based on the trailing twelve months to December 2022).
The ‘return’ is the profit over the last twelve months. That means that for every $1 worth of shareholders’ equity, the company generated $0.16 in profit.
Why Is ROE Important For 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.
Autoliv’s Earnings Growth And 16% ROE
To start with, Autoliv’s ROE looks acceptable. Further, the company’s ROE is similar to the industry average of 14%. For this reason, Autoliv’s five year net income decline of 8.4% raises the question as to why the decent ROE didn’t translate into growth. So, there might be some other aspects that could explain this. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
So, as a next step, we compared Autoliv’s performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 11% in the same period.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Autoliv fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Autoliv Making Efficient Use Of Its Profits?
Autoliv’s declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 51% (or a retention ratio of 49%). With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. To know the 2 risks we have identified for Autoliv visit our risks dashboard for free.
In addition, Autoliv 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 29% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company’s ROE to 26%, over the same period.
Conclusion
In total, it does look like Autoliv has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren’t reaping the benefits of the high rate of return. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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.
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