AGL Energy (ASX:AGL) has had a rough month with its share price down 2.4%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on AGL 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Is ROE Calculated?
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 AGL Energy is:
12% = AU$938m ÷ AU$8.0b (Based on the trailing twelve months to December 2019).
The 'return' is the yearly profit. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.12 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learnt that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.
AGL Energy's Earnings Growth And 12% ROE
To begin with, AGL Energy seems to have a respectable ROE. On comparing with the average industry ROE of 8.6% the company's ROE looks pretty remarkable. This certainly adds some context to AGL Energy's exceptional 40% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings 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.
As a next step, we compared AGL Energy's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 8.3%.
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. Is AGL fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is AGL Energy Using Its Retained Earnings Effectively?
The high three-year median payout ratio of 82% (implying that it keeps only 18% of profits) for AGL Energy suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.
Moreover, AGL 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 over the next three years is expected to be approximately 84%. Still, forecasts suggest that AGL Energy's future ROE will drop to 7.3% even though the the company's payout ratio is not expected to change by much.
Overall, we are quite pleased with AGL Energy's performance. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. 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.
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