Are Robust Financials Driving The Recent Rally In Quanta Services, Inc.'s (NYSE:PWR) Stock?
Quanta Services (NYSE:PWR) has had a great run on the share market with its stock up by a significant 26% over the last three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on Quanta Services' ROE.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
See our latest analysis for Quanta Services
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 Quanta Services is:
12% = US$546m ÷ US$4.5b (Based on the trailing twelve months to June 2021).
The 'return' is the income the business earned over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.12 in profit.
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. 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. 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.
Quanta Services' Earnings Growth And 12% ROE
At first glance, Quanta Services seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 10%. This probably goes some way in explaining Quanta Services' significant 20% net income growth over the past five years amongst other factors. We believe that there might also be 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.
Next, on comparing Quanta Services' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 20% 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. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for PWR? You can find out in our latest intrinsic value infographic research report.
Is Quanta Services Using Its Retained Earnings Effectively?
Quanta Services' ' three-year median payout ratio is on the lower side at 6.2% implying that it is retaining a higher percentage (94%) of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.
Besides, Quanta Services has been paying dividends over a period of three 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 is expected to drop to 2.9% over the next three years. As a result, the expected drop in Quanta Services' payout ratio explains the anticipated rise in the company's future ROE to 17%, over the same period.
Summary
Overall, we are quite pleased with Quanta Services' 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. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. 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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