Advanced Braking Technology Limited's (ASX:ABV) Stock On An Uptrend: Could Fundamentals Be Driving The Momentum?

Simply Wall St
·3 min read

Most readers would already be aware that Advanced Braking Technology's (ASX:ABV) stock increased significantly by 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. Particularly, we will be paying attention to Advanced Braking Technology's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Advanced Braking Technology

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 Advanced Braking Technology is:

9.7% = AU$417k ÷ AU$4.3m (Based on the trailing twelve months to December 2020).

The 'return' is the profit over the last twelve months. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.10.

What Has ROE Got To Do With 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 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 Advanced Braking Technology's Earnings Growth And 9.7% ROE

At first glance, Advanced Braking Technology's ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 20% either. Despite this, surprisingly, Advanced Braking Technology saw an exceptional 22% net income growth over the past five years. Therefore, there could be other reasons behind this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

Next, on comparing with the industry net income growth, we found that Advanced Braking Technology's growth is quite high when compared to the industry average growth of 15% in the same period, which is great to see.

past-earnings-growth
past-earnings-growth

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). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Advanced Braking Technology's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Advanced Braking Technology Using Its Retained Earnings Effectively?

Summary

Overall, we feel that Advanced Braking Technology certainly does have some positive factors to consider. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. 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 Advanced Braking Technology.

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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