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Is Weakness In Airtel Africa Plc (LON:AAF) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

·4-min read

With its stock down 5.8% over the past three months, it is easy to disregard Airtel Africa (LON:AAF). 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. Particularly, we will be paying attention to Airtel Africa'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Airtel Africa

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 Airtel Africa is:

21% = US$755m ÷ US$3.6b (Based on the trailing twelve months to March 2022).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.21.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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.

Airtel Africa's Earnings Growth And 21% ROE

To start with, Airtel Africa's ROE looks acceptable. On comparing with the average industry ROE of 10% the company's ROE looks pretty remarkable. This certainly adds some context to Airtel Africa's exceptional 47% net income growth seen over the past five years. We reckon that there could also be other factors at play here. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Airtel Africa's growth is quite high when compared to the industry average growth of 7.5% in the same period, which is great to see.

past-earnings-growth
past-earnings-growth

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Airtel Africa is trading on a high P/E or a low P/E, relative to its industry.

Is Airtel Africa Making Efficient Use Of Its Profits?

Airtel Africa has a three-year median payout ratio of 36% (where it is retaining 64% of its income) which is not too low or not too high. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Airtel Africa is reinvesting its earnings efficiently.

Moreover, Airtel Africa is determined to keep sharing its profits with shareholders which we infer from its long history of three years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 23% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.

Summary

On the whole, we feel that Airtel Africa's performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.

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

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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