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With its stock down 12% over the past three months, it is easy to disregard AO World (LON:AO.). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on AO World's ROE.
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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
View our latest analysis for AO World
How Is ROE Calculated?
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 AO World is:
19% = UK£26m ÷ UK£142m (Based on the trailing twelve months to September 2024).
The 'return' is the yearly profit. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.19.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
AO World's Earnings Growth And 19% ROE
To begin with, AO World seems to have a respectable ROE. Especially when compared to the industry average of 10.0% the company's ROE looks pretty impressive. This certainly adds some context to AO World's exceptional 34% net income growth seen over the past five years. However, there could also be other causes behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.
As a next step, we compared AO World's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 10%.
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 AO. worth today? The intrinsic value infographic in our free research report helps visualize whether AO. is currently mispriced by the market.