Yahoo Finance AvalonBay Communities, Inc.'s (NYSE:AVB) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?
AvalonBay Communities (NYSE:AVB) has had a great run on the share market with its stock up by a significant 16% over the last three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. In this article, we decided to focus on AvalonBay Communities' ROE.
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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out our latest analysis for AvalonBay Communities
How To Calculate Return On Equity?
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 AvalonBay Communities is:
7.5% = US$802m ÷ US$11b (Based on the trailing twelve months to March 2021).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.08 in profit.
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.
AvalonBay Communities' Earnings Growth And 7.5% ROE
When you first look at it, AvalonBay Communities' ROE doesn't look that attractive. However, the fact that the company's ROE is higher than the average industry ROE of 4.6%, is definitely interesting. But then again, seeing that AvalonBay Communities' net income shrunk at a rate of 2.9% in the past five years, makes us think again. Bear in mind, the company does have a slightly low ROE. It is just that the industry ROE is lower. Therefore, the decline in earnings could also be the result of this.
That being said, we compared AvalonBay Communities' performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 10% in the same period.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is AVB worth today? The intrinsic value infographic in our free research report helps visualize whether AVB is currently mispriced by the market.
Is AvalonBay Communities Making Efficient Use Of Its Profits?
AvalonBay Communities has a very high three-year median payout ratio of 66%, implying that it retains only 34% of its profits. However, it's not unusual to see a REIT with such a high payout ratio mainly due to statutory requirements. So this probably explains the company's shrinking earnings.
In addition, AvalonBay Communities has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 75%. As a result, AvalonBay Communities' ROE is not expected to change by much either, which we inferred from the analyst estimate of 6.1% for future ROE.
Summary
In total, we're a bit ambivalent about AvalonBay Communities' performance. Specifically, the low earnings growth is a bit concerning, especially given that the company has a respectable rate of return. Investors may have benefitted, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
This article by Simply Wall St is general in nature. 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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