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EnerSys (NYSE:ENS) has had a rough three months with its share price down 23%. It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Particularly, we will be paying attention to EnerSys' ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How To Calculate Return On Equity?
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 EnerSys is:
9.7% = US$152m ÷ US$1.6b (Based on the trailing twelve months to July 2021).
The 'return' is the income the business earned over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.10 in profit.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.
EnerSys' Earnings Growth And 9.7% ROE
At first glance, EnerSys' ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 13% either. As a result, EnerSys' flat net income growth over the past five years doesn't come as a surprise given its lower ROE.
As a next step, we compared EnerSys' net income growth with the industry and discovered that the industry saw an average growth of 7.1% in the same period.
Earnings growth is a huge factor in stock valuation. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if EnerSys is trading on a high P/E or a low P/E, relative to its industry.
Is EnerSys Efficiently Re-investing Its Profits?
EnerSys has a low three-year median payout ratio of 20% (or a retention ratio of 80%) but the negligible earnings growth number doesn't reflect this as high growth usually follows high profit retention.
Moreover, EnerSys has been paying dividends for eight years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.
In total, we're a bit ambivalent about EnerSys' performance. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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. 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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