Does the weak fundamentals of the Australian Unity Office Fund (ASX:AOF) mean that the market could correct its share price?

Most readers will already know that Australian Unity Office Fund (ASX:AOF) stock has risen a significant 10% over the past week. However, we have decided to pay close attention to its weak financials as we doubt the current momentum will continue given the scenario. In particular, we will pay attention to the ROE of the Australian Unity Office Fund today.

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 other words, it reveals the company’s success in turning shareholders’ investments into profits.

Check out our latest analysis for Australian Unity Office Fund

How to calculate return on equity?

ROE can be calculated using the formula:

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

So, based on the above formula, the ROE for Australian Unity Office Fund is:

2.3% = AU$10.0 million ÷ AU$439 million (based on trailing twelve months to December 2021).

“Yield” is the income the business has earned over the past year. This means that for every Australian dollar of equity, the company generated a profit of 0.02 Australian dollars.

What does ROE have to do with earnings growth?

We have already established that ROE serves as an effective profit-generating indicator for a company’s future earnings. Based on the share of its profits that the company chooses to reinvest or “keep”, we are then able to assess a company’s future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and earnings retention, the higher a company’s growth rate compared to companies that don’t necessarily exhibit these characteristics.

Australian Unity Office Fund earnings growth and ROE of 2.3%

It is clear that the ROE of the Australian Unity Office Fund is rather weak. Not only that, even compared to the industry average of 15%, the company’s ROE is quite unremarkable. For this reason, the Australian Unity Office Fund’s 27% decline in net income over five years is not surprising given its lower ROE. We believe there could also be other aspects that negatively influence the company’s earnings outlook. For example, the company has misallocated capital or the company has a very high payout ratio.

That being said, we compared the performance of the Australian Unity Office Fund with the industry and were concerned when we found that while the company had reduced profits, the industry had increased profits at a rate of 11 % over the same period.

ASX: AOF Past Earnings Growth May 30, 2022

Earnings growth is an important factor in stock valuation. The investor should try to establish whether the expected growth or decline in earnings, as the case may be, is taken into account. This will help him determine if the future of the stock looks bright or ominous. If you’re wondering about the valuation of Australian Unity Office Fund, check out this indicator of its price/earnings ratio, relative to its sector.

Does the Australian Unity Office Fund use its retained earnings effectively?

Australian Unity Office Fund appears to be paying out most of its income in the form of dividends judging by its three-year median payout ratio of 83% (meaning the company only retains 17% of profits). However, this is typical for REITs as they are often required by law to distribute most of their profits. As a result, this probably explains why its profits have declined.

Additionally, Australian Unity Office Fund has been paying dividends for six years, which is a considerable length of time, suggesting that management must have perceived that shareholders preferred consistent dividends even though profits have declined. Our latest analyst data shows that the company’s future payout ratio over the next three years is expected to be around 94%. Either way, the Australian Unity Office Fund’s future ROE is expected to reach 4.6% despite little change expected in its payout ratio.

Conclusion

All in all, we would find it hard to think before deciding on any investment action regarding the Australian Unity Office Fund. The company has experienced a lack of earnings growth due to the fact that it retains very little profit and what little it retains is reinvested at a very low rate of return. That said, looking at current analyst estimates, we found that the company’s earnings growth rate should see a huge improvement. Are these analyst expectations based on general industry expectations or company fundamentals? Click here to access our analyst forecast page for the company.

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.

Jose C. Birney