Avnet (NASDAQ:AVT) has had a rough month with its share price down 8.8%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Avnet's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Avnet

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 Avnet is:

17% = US$692m ÷ US$4.2b (Based on the trailing twelve months to July 2022).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.17 in profit.

What Is The Relationship Between ROE And 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 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 Avnet's Earnings Growth And 17% ROE

To start with, Avnet's ROE looks acceptable. Especially when compared to the industry average of 14% the company's ROE looks pretty impressive. Probably as a result of this, Avnet was able to see an impressive net income growth of 31% over the last five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that Avnet's growth is quite high when compared to the industry average growth of 17% in the same period, which is great to see.

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for AVT? You can find out in our latest intrinsic value infographic research report.

Is Avnet Making Efficient Use Of Its Profits?

Avnet's three-year median payout ratio to shareholders is 19%, which is quite low. This implies that the company is retaining 81% of its profits. So it looks like Avnet is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Besides, Avnet has been paying dividends over a period of nine years. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 17% of its profits over the next three years. Still, forecasts suggest that Avnet's future ROE will drop to 12% even though the the company's payout ratio is not expected to change by much.

Conclusion

Overall, we are quite pleased with Avnet's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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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