With its stock down 5.9% over the past three months, it is easy to disregard Contact Energy (NZSE:CEN). Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company’s key financial indicators. In this article, we decided to focus on Contact Energy’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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
See our latest analysis for Contact Energy
How Do You Calculate Return On Equity?
ROE 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 Contact Energy is:
4.5% = NZ$127m ÷ NZ$2.8b (Based on the trailing twelve months to June 2023).
The ‘return’ is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each NZ$1 of shareholders’ capital it has, the company made NZ$0.05 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. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Contact Energy’s Earnings Growth And 4.5% ROE
At first glance, Contact Energy’s ROE doesn’t look very promising. Next, when compared to the average industry ROE of 8.1%, the company’s ROE leaves us feeling even less enthusiastic. Therefore, Contact Energy’s flat earnings over the past five years can possibly be explained by the low ROE amongst other factors.
As a next step, we compared Contact Energy’s net income growth with the industry and discovered that the company’s growth is slightly less than the industry average growth of 0.8% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company’s expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Contact Energy fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Contact Energy Making Efficient Use Of Its Profits?
Contact Energy has a three-year median payout ratio as high as 185% meaning that the company is paying a dividend which is beyond its means. This does go some way in explaining the negligible earnings growth seen by Contact Energy. Its usually very hard to sustain dividend payments that are higher than reported profits. This is quite a risky position to be in. You can see the 2 risks we have identified for Contact Energy by visiting our risks dashboard for free on our platform here.
Additionally, Contact Energy has paid dividends over a period of at least ten years, which means that the company’s management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts’ consensus data, we found that the company’s future payout ratio is expected to drop to 113% over the next three years. The fact that the company’s ROE is expected to rise to 11% over the same period is explained by the drop in the payout ratio.
Summary
Overall, we would be extremely cautious before making any decision on Contact Energy. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. Having said that, looking at current analyst estimates, we found that the company’s earnings growth rate is expected to see a huge improvement. 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.
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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.
