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Aeris Environmental Ltd (ASX:AEI) Stock's Been Sliding But Fundamentals Look Decent: Will The Market Correct The Share Price In The Future?

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Aeris Environmental (ASX:AEI) has had a rough month with its share price down 24%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Aeris Environmental's ROE today.

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 Aeris Environmental

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 Aeris Environmental is:

8.8% = AU$1.5m ÷ AU$17m (Based on the trailing twelve months to December 2020).

The 'return' refers to a company's earnings over the last year. That means that for every A$1 worth of shareholders' equity, the company generated A$0.09 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Aeris Environmental's Earnings Growth And 8.8% ROE

At first glance, Aeris Environmental's ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 8.4%. Moreover, we are quite pleased to see that Aeris Environmental's net income grew significantly at a rate of 21% over the last five years. Considering the moderately low ROE, it is quite possible that there might be some 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.

We then compared Aeris Environmental's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 12% in the same period.

past-earnings-growth
past-earnings-growth

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. 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 Aeris Environmental is trading on a high P/E or a low P/E, relative to its industry.

Is Aeris Environmental Using Its Retained Earnings Effectively?

Summary

In total, it does look like Aeris Environmental has some positive aspects to its business. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. 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. You can see the 3 risks we have identified for Aeris Environmental by visiting our risks dashboard for free on our platform here.

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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