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Aviva plc's (LON:AV.) Stock Has Shown A Decent Performance: Have Financials A Role To Play?

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Aviva's (LON:AV.) stock is up by 3.1% over the past week. As most would know, long-term fundamentals have a strong correlation with market price movements, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Aviva's ROE.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Aviva

How Do You Calculate Return On Equity?

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 Aviva is:

6.9% = UK£1.3b ÷ UK£19b (Based on the trailing twelve months to June 2021).

The 'return' refers to a company's earnings over the last year. That means that for every £1 worth of shareholders' equity, the company generated £0.07 in profit.

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. 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 Aviva's Earnings Growth And 6.9% ROE

On the face of it, Aviva's ROE is not much to talk about. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 13%. However, the moderate 19% net income growth seen by Aviva over the past five years is definitely a positive. So, there might 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.

When you consider the fact that the industry earnings have shrunk at a rate of 2.8% in the same period, the company's net income growth is pretty remarkable.

past-earnings-growth
past-earnings-growth

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is Aviva fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Aviva Making Efficient Use Of Its Profits?

Aviva has a significant three-year median payout ratio of 53%, meaning that it is left with only 47% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Moreover, Aviva is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 58% of its profits over the next three years. Regardless, the future ROE for Aviva is predicted to rise to 8.7% despite there being not much change expected in its payout ratio.

Summary

In total, it does look like Aviva has some positive aspects to its business. That is, quite an impressive growth in earnings. However, the low profit retention means that the company's earnings growth could have been higher, had it been reinvesting a higher portion of its profits. 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.

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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