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Is Weakness In Avnet, Inc. (NASDAQ:AVT) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

It is hard to get excited after looking at Avnet's (NASDAQ:AVT) recent performance, when its stock has declined 8.0% over the past month. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Avnet's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Avnet

How Is ROE Calculated?

ROE can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

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So, based on the above formula, the ROE for Avnet is:

19% = US$858m ÷ US$4.4b (Based on the trailing twelve months to December 2022).

The 'return' is the amount earned after tax over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.19 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 19% ROE

To begin with, Avnet seems to have a respectable ROE. Especially when compared to the industry average of 13% the company's ROE looks pretty impressive. Probably as a result of this, Avnet was able to see an impressive net income growth of 54% over the last five years. We reckon that there could also be other factors at play here. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Avnet's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 18%.

past-earnings-growth
past-earnings-growth

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. What is AVT worth today? The intrinsic value infographic in our free research report helps visualize whether AVT is currently mispriced by the market.

Is Avnet Efficiently Re-investing Its Profits?

Avnet's three-year median payout ratio to shareholders is 14%, which is quite low. This implies that the company is retaining 86% of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Moreover, Avnet 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. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 21% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company's expected ROE (to 12%) over the same period.

Summary

In total, we are pretty happy with Avnet's performance. 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. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. 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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