adidas AG (ETR:ADS) Stocks are down but fundamentals look good: will the market correct the stock price going forward?

It’s hard to get excited after watching the recent performance of adidas (ETR: ADS), as its stock is down 22% in the past three months. However, stock prices are usually determined by a company’s long-term finances, which in this case seem quite respectable. Specifically, we decided to study the ROE of adidas in this article.

ROE or return on equity is a useful tool for evaluating how effectively a company can generate returns on the investment it has received from its shareholders. In short, ROE shows the profit that each dollar generates in relation to the investments of its shareholders.

See our latest review for adidas

How to calculate return on equity?

The ROE formula is:

Return on equity = Net income (from continuing operations) ÷ Equity

So, based on the formula above, adidas’ ROE is:

19% = €1.3 billion ÷ €7.0 billion (based on the last twelve months to March 2022).

The “yield” is the profit of the last twelve months. Another way to think about this is that for every €1 of equity, the company was able to make a profit of €0.19.

What is the relationship between ROE and earnings growth?

So far we have learned that ROE is a measure of a company’s profitability. Depending on how much of those earnings the company reinvests or “keeps”, and how efficiently it does so, we are then able to gauge a company’s earnings growth potential. Generally speaking, all things being equal, companies with high return on equity and earnings retention have a higher growth rate than companies that do not share these attributes.

adidas earnings growth and ROE of 19%

At first glance, adidas seems to have a decent ROE. Even when compared to the industry average of 17%, the company’s ROE looks pretty decent. For this reason, adidas’ 4.8% decline in five-year net income raises the question of why decent ROE has not translated into growth. We believe there could be other factors at play here that are preventing the company from growing. These include poor revenue retention or poor capital allocation.

That being said, we benchmarked adidas’ performance against the industry and became concerned when we found that while the company had cut profits, the industry had increased profits at a rate of 1, 7% over the same period.

XTRA: ADS Past Earnings Growth June 23, 2022

Earnings growth is an important metric to consider when evaluating a stock. It is important for an investor to know whether the market has priced in the expected growth (or decline) in the company’s earnings. By doing so, they will get an idea if the stock is headed for clear blue waters or if swampy waters are waiting. What is ADS worth today? The intrinsic value infographic in our free research report visualizes whether ADS is currently being mispriced by the market.

Does Adidas use its profits efficiently?

Despite a three-year normal median payout ratio of 40% (where it keeps 60% of its profits), adidas has seen declining profits, as seen above. So there could be other explanations for this. For example, the company’s business may deteriorate.

Additionally, adidas has been paying dividends for at least a decade, suggesting that management must have perceived that shareholders preferred dividends to earnings growth. Based on the latest analyst estimates, we found that the company’s future payout ratio over the next three years is expected to remain stable at 38%. Either way, adidas’ future ROE is expected to reach 33% despite little change expected in its payout ratio.

Summary

Overall, we think adidas has positive attributes. Still, the low earnings growth is a bit of a concern, especially since the company has a high rate of return and reinvests a huge portion of its earnings. At first glance, there could be other factors, which do not necessarily control the business, that are preventing growth. That said, we studied the latest analyst forecasts and found that while the company has cut earnings in the past, analysts expect earnings to increase in the future. For more on the company’s future earnings growth forecast, check out this free analyst forecast report for the company to learn more.

This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.

James T. Quintero