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Avangrid (NYSE:AGR) has had a rough month with its share price down 6.2%. 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. Particularly, we will be paying attention to Avangrid's ROE today.
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.
How Do You Calculate Return On Equity?
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 Avangrid is:
3.2% = US$638m ÷ US$20b (Based on the trailing twelve months to June 2021).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.03 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
Avangrid's Earnings Growth And 3.2% ROE
It is hard to argue that Avangrid's ROE is much good in and of itself. Not just that, even compared to the industry average of 10%, the company's ROE is entirely unremarkable. Accordingly, Avangrid's low net income growth of 4.7% over the past five years can possibly be explained by the low ROE amongst other factors.
We then performed a comparison between Avangrid's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 5.2% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Avangrid's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Avangrid Efficiently Re-investing Its Profits?
The high three-year median payout ratio of 91% (that is, the company retains only 8.6% of its income) over the past three years for Avangrid suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.
Moreover, Avangrid has been paying dividends for six years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 73% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 5.6%, over the same period.
On the whole, Avangrid's performance is quite a big let-down. While no doubt its earnings growth is pretty respectable, 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, specially during troubled times. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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. 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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