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

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With its stock down 32% over the past three months, it is easy to disregard ASOS (LON:ASC). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study ASOS’ ROE in this article.

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 ASOS

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 ASOS is:

12% = UK£128m ÷ UK£1.0b (Based on the trailing twelve months to August 2021).

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 £0.12.

What Is The Relationship Between ROE And 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.

A Side By Side comparison of ASOS’ Earnings Growth And 12% ROE

To start with, ASOS’ ROE looks acceptable. Even when compared to the industry average of 12% the company’s ROE looks quite decent. Consequently, this likely laid the ground for the impressive net income growth of 26% seen over the past five years by ASOS. We reckon that there could also be other factors at play here. 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.

As a next step, we compared ASOS’ net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 26% in the same period.

past-earnings-growth

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is ASOS fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is ASOS Efficiently Re-investing Its Profits?

ASOS doesn’t pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the high earnings growth number that we discussed above.

Conclusion

On the whole, we feel that ASOS’ performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, the company’s earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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