Yahoo Finance Is The Market Rewarding Contact Energy Limited (NZSE:CEN) With A Negative Sentiment As A Result Of Its Mixed Fundamentals?
It is hard to get excited after looking at Contact Energy's (NZSE:CEN) recent performance, when its stock has declined 5.8% over the past three months. It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Specifically, we decided to study Contact Energy's ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out our latest analysis for Contact Energy
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Contact Energy is:
6.4% = NZ$182m ÷ NZ$2.8b (Based on the trailing twelve months to June 2022).
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$0.06.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
A Side By Side comparison of Contact Energy's Earnings Growth And 6.4% ROE
When you first look at it, Contact Energy's ROE doesn't look that attractive. Next, when compared to the average industry ROE of 9.3%, the company's ROE leaves us feeling even less enthusiastic. Although, we can see that Contact Energy saw a modest net income growth of 13% over the past five years. So, the growth in the company's earnings could probably have been caused by other variables. For instance, the company has a low payout ratio or is being managed efficiently.
We then compared Contact Energy's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 9.5% 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. If you're wondering about Contact Energy's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Contact Energy Making Efficient Use Of Its Profits?
The really high three-year median payout ratio of 164% for Contact Energy suggests that the company is paying its shareholders more than what it is earning. Still the company's earnings have grown respectably. 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.
Moreover, Contact Energy is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 104% over the next three years. The fact that the company's ROE is expected to rise to 9.7% over the same period is explained by the drop in the payout ratio.
Summary
In total, we're a bit ambivalent about Contact Energy's performance. While the company has posted impressive earnings growth, its poor ROE and low earnings retention makes us doubtful if that growth could continue, if by any chance the business is faced with any sort of risk. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. 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.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
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