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Contact Energy (NZSE:CEN) has had a rough week with its share price down 17%. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. In this article, we decided to focus on Contact Energy's 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Do You Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Contact Energy is:
4.9% = NZ$130m ÷ NZ$2.7b (Based on the trailing twelve months to December 2019).
The 'return' is the profit over the last twelve months. So, this means that for every NZ$1 of its shareholder's investments, the company generates a profit of NZ$0.05.
Why Is ROE Important For 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 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.
Contact Energy's Earnings Growth And 4.9% ROE
On the face of it, Contact Energy's ROE is not much to talk about. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 8.9%. However, the moderate 15% net income growth seen by Contact Energy over the past five years is definitely a positive. So, there might be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.
We then performed a comparison between Contact Energy's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 15% in the same period.
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 CEN worth today? The intrinsic value infographic in our free research report helps visualize whether CEN is currently mispriced by the market.
Is Contact Energy Efficiently Re-investing Its Profits?
Contact Energy's high three-year median payout ratio of 174% suggests that the company is paying out more to its shareholders than what it is making. In spite of this, the company was able to grow its earnings respectably, as we saw above. Although, the high payout ratio is certainly something we would keep an eye on if the company is not able to keep up its growth, or if business deteriorates. To know the 4 risks we have identified for Contact Energy visit our risks dashboard for free.
Additionally, Contact Energy has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 179%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 5.7%.
In total, we're a bit ambivalent about Contact Energy's performance. While no doubt its earnings growth is pretty substantial, its ROE and earnings retention is quite poor. So while the company has managed to grow its earnings in spite of this, we are unconvinced if this growth could extend, especially during troubled times. 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 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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