Yahoo Finance Is The Market Rewarding Contact Energy Limited (NZSE:CEN) With A Negative Sentiment As A Result Of Its Mixed Fundamentals?
With its stock down 5.8% over the past month, it is easy to disregard Contact Energy (NZSE:CEN). It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. 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.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. 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 To Calculate Return On Equity?
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 Contact Energy is:
8.2% = NZ$243m ÷ NZ$3.0b (Based on the trailing twelve months to December 2021).
The 'return' is the amount earned after tax over the last twelve months. That means that for every NZ$1 worth of shareholders' equity, the company generated NZ$0.08 in profit.
What Has ROE Got To Do With Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
Contact Energy's Earnings Growth And 8.2% ROE
At first glance, Contact Energy's ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 8.2%, we may spare it some thought. On the other hand, Contact Energy reported a moderate 10.0% net income growth over the past five years. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
Next, on comparing with the industry net income growth, we found that the growth figure reported by Contact Energy compares quite favourably to the industry average, which shows a decline of 4.5% 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). This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for CEN? You can find out in our latest intrinsic value infographic research report.
Is Contact Energy Efficiently Re-investing Its Profits?
Contact Energy has a very high three-year median payout ratio of 175% suggesting that the company's shareholders are getting paid from more than just the company's earnings. In spite of this, the company was able to grow its earnings respectably, as we saw above. That being said, the high payout ratio could be worth keeping an eye on in case the company is unable to keep up its current growth momentum. Our risks dashboard should have the 2 risks we have identified for Contact Energy.
Besides, Contact Energy has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 135% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.
Conclusion
On the whole, we feel that the performance shown by Contact Energy can be open to many interpretations. 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. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings 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.
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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.
