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With its stock down 4.1% over the past three months, it is easy to disregard Sempra (NYSE:SRE). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Sempra's ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How To Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Sempra is:
8.7% = US$2.2b ÷ US$26b (Based on the trailing twelve months to June 2021).
The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.09.
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. 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. 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.
Sempra's Earnings Growth And 8.7% ROE
At first glance, Sempra's ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 9.2%, we may spare it some thought. Even so, Sempra has shown a fairly decent growth in its net income which grew at a rate of 18%. 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 instance, the company has a low payout ratio or is being managed efficiently.
We then compared Sempra'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 6.0% in the same period.
Earnings growth is an important metric to consider when valuing a stock. 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. Is SRE fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Sempra Using Its Retained Earnings Effectively?
The high three-year median payout ratio of 59% (or a retention ratio of 41%) for Sempra suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.
Additionally, Sempra has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 57%. Regardless, the future ROE for Sempra is predicted to rise to 11% despite there being not much change expected in its payout ratio.
In total, it does look like Sempra has some positive aspects to its business. Namely, its high earnings growth. We do however feel that the earnings growth number could have been even higher, had the company been reinvesting more of its earnings and paid out less dividends. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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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