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Can Trustpower Limited's (NZSE:TPW) Weak Financials Pull The Plug On The Stock's Current Momentum On Its Share Price?

Trustpower's (NZSE:TPW) stock is up by a considerable 14% over the past month. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. Particularly, we will be paying attention to Trustpower's ROE today.

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.

Check out our latest analysis for Trustpower

How Do You Calculate Return On Equity?

The formula for ROE is:

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Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Trustpower is:

8.4% = NZ$93m ÷ NZ$1.1b (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. That means that for every NZ$1 worth of shareholders' equity, the company generated NZ$0.08 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. 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. 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.

Trustpower's Earnings Growth And 8.4% ROE

At first glance, Trustpower's ROE doesn't look very promising. Although a closer study shows that the company's ROE is higher than the industry average of 5.5% which we definitely can't overlook. Still, Trustpower has seen a flat net income growth over the past five years. Remember, the company's ROE is a bit low to begin with, just that it is higher than the industry average. Therefore, the low to flat growth in earnings could also be the result of this.

As a next step, we compared Trustpower's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 21% in the same period.

past-earnings-growth
past-earnings-growth

Earnings growth is an important metric to consider when valuing a stock. 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. What is TPW worth today? The intrinsic value infographic in our free research report helps visualize whether TPW is currently mispriced by the market.

Is Trustpower Efficiently Re-investing Its Profits?

Trustpower's very high three-year median payout ratio of 111% suggests that the company is paying its shareholders more than what it is earning. The absence in growth is therefore not surprising. Paying a dividend beyond their means is usually not viable over the long term. This is quite a risky position to be in. To know the 2 risks we have identified for Trustpower visit our risks dashboard for free.

Additionally, Trustpower has paid dividends over a period of four years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 103%. Accordingly, forecasts suggest that Trustpower's future ROE will be 9.4% which is again, similar to the current ROE.

Summary

In total, we would have a hard think before deciding on any investment action concerning Trustpower. The company has shown a disappointing growth in its earnings as a result of it retaining little to almost none of its profits. So, the decent ROE it does have, is not much useful to investors given that the company is reinvesting very little into its business. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.