With its stock down 15% over the past three months, it is easy to disregard Iberdrola (BME:IBE). 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. Particularly, we will be paying attention to Iberdrola's ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.
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 Iberdrola is:
8.8% = €4.2b ÷ €47b (Based on the trailing twelve months to March 2020).
The 'return' is the profit over the last twelve months. That means that for every €1 worth of shareholders' equity, the company generated €0.09 in profit.
What Is The Relationship Between ROE And Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
A Side By Side comparison of Iberdrola's Earnings Growth And 8.8% ROE
At first glance, Iberdrola seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 8.0%. This probably goes some way in explaining Iberdrola's moderate 8.6% growth over the past five years amongst other factors.
We then compared Iberdrola'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 2.8% 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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Iberdrola's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Iberdrola Using Its Retained Earnings Effectively?
Iberdrola's three-year median payout ratio to shareholders is 8.4% (implying that it retains 92% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.
Besides, Iberdrola has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 72% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.
Overall, we are quite pleased with Iberdrola's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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 company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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