The AZEK Company Inc.'s (NYSE:AZEK) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

Simply Wall St · 10/25/2024 16:25

It is hard to get excited after looking at AZEK's (NYSE:AZEK) recent performance, when its stock has declined 8.9% over the past month. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to AZEK's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for AZEK

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 AZEK is:

12% = US$164m ÷ US$1.4b (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.12 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.

AZEK's Earnings Growth And 12% ROE

At first glance, AZEK seems to have a decent ROE. Be that as it may, the company's ROE is still quite lower than the industry average of 18%. That being the case, the significant five-year 56% net income growth reported by AZEK comes as a pleasant surprise. Therefore, there could be other causes behind this growth. For instance, the company has a low payout ratio or is being managed efficiently. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this certainly also provides some context to the high earnings growth seen by the company.

Next, on comparing with the industry net income growth, we found that AZEK's growth is quite high when compared to the industry average growth of 17% in the same period, which is great to see.

past-earnings-growth
NYSE:AZEK Past Earnings Growth October 25th 2024

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. Doing so will help them establish if the stock's future looks promising or ominous. 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 AZEK is trading on a high P/E or a low P/E, relative to its industry.

Is AZEK Making Efficient Use Of Its Profits?

Given that AZEK doesn't pay any regular dividends to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.

Conclusion

On the whole, we feel that AZEK's performance has been quite good. Specifically, we like that it has been reinvesting a high portion of its profits at a moderate rate of return, resulting in earnings expansion. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.