Can Mixed Fundamentals Have A Negative Impact on Algonquin Power & Utilities Corp. (TSE:AQN) Current Share Price Momentum?
Algonquin Power & Utilities' (TSE:AQN) stock is up by a considerable 19% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study Algonquin Power & Utilities' 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out our latest analysis for Algonquin Power & Utilities
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 Algonquin Power & Utilities is:
9.4% = US$457m ÷ US$4.9b (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 CA$1 worth of equity, the company was able to earn CA$0.09 in profit.
Why Is ROE Important For 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.
Algonquin Power & Utilities' Earnings Growth And 9.4% ROE
When you first look at it, Algonquin Power & Utilities' ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 9.6%, we may spare it some thought. Looking at Algonquin Power & Utilities' exceptional 55% five-year net income growth in particular, we are definitely impressed. Considering the moderately low ROE, it is quite possible that there might be some other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.
We then compared Algonquin Power & Utilities' 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 7.6% 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. Is AQN fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Algonquin Power & Utilities Making Efficient Use Of Its Profits?
Algonquin Power & Utilities' very high three-year median payout ratio of 131% suggests that the company is paying more to its shareholders than what it is earning. Despite this, the company's earnings grew significantly as we saw above. Having said that, the high payout ratio is definitely risky and something to keep an eye on. You can see the 6 risks we have identified for Algonquin Power & Utilities by visiting our risks dashboard for free on our platform here.
Moreover, Algonquin Power & Utilities is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 87% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.
Conclusion
On the whole, we feel that the performance shown by Algonquin Power & Utilities can be open to many interpretations. While the company has posted impressive earnings growth, its poor ROE and low earnings retention makes us doubtful if that growth could continue, if by any chance the business is faced with any sort of risk. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. 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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