Energy One Limited's (ASX:EOL) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?
Most readers would already be aware that Energy One's (ASX:EOL) stock increased significantly by 52% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Specifically, we decided to study Energy One's ROE in this article.
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.
See our latest analysis for Energy One
How Is ROE Calculated?
Return on equity can be calculated by using the formula:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Energy One is:
8.8% = AU$1.6m ÷ AU$19m (Based on the trailing twelve months to June 2020).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.09 in profit.
What Is The Relationship Between ROE And 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. 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.
Energy One's Earnings Growth And 8.8% ROE
When you first look at it, Energy One's ROE doesn't look that attractive. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 13%. However, we we're pleasantly surprised to see that Energy One grew its net income at a significant rate of 29% in the last five years. We reckon that there could be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.
We then compared Energy One'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 11% 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 Energy One fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Energy One Efficiently Re-investing Its Profits?
Energy One's three-year median payout ratio is a pretty moderate 44%, meaning the company retains 56% of its income. So it seems that Energy One is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.
Besides, Energy One has been paying dividends over a period of four years. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 40%. Still, forecasts suggest that Energy One's future ROE will rise to 17% even though the the company's payout ratio is not expected to change by much.
Conclusion
On the whole, we do feel that Energy One has some positive attributes. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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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