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Spark Infrastructure Group's (ASX:SKI) Has Been On A Rise But Financial Prospects Look Weak: Is The Stock Overpriced?

Simply Wall St
·4 min read

Spark Infrastructure Group (ASX:SKI) has had a great run on the share market with its stock up by a significant 6.3% over the last month. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. Particularly, we will be paying attention to Spark Infrastructure Group's ROE today.

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.

View our latest analysis for Spark Infrastructure Group

How To 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 Spark Infrastructure Group is:

4.8% = AU$76m ÷ AU$1.6b (Based on the trailing twelve months to June 2020).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.05 in profit.

What Has ROE Got To Do With 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 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.

Spark Infrastructure Group's Earnings Growth And 4.8% ROE

When you first look at it, Spark Infrastructure Group's ROE doesn't look that attractive. Yet, a closer study shows that the company's ROE is similar to the industry average of 5.2%. But Spark Infrastructure Group saw a five year net income decline of 26% over the past five years. Remember, the company's ROE is a bit low to begin with. Hence, this goes some way in explaining the shrinking earnings.

So, as a next step, we compared Spark Infrastructure Group's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 8.6% in the same period.

past-earnings-growth
past-earnings-growth

Earnings growth is a huge factor in stock valuation. 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. If you're wondering about Spark Infrastructure Group's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Spark Infrastructure Group Making Efficient Use Of Its Profits?

Spark Infrastructure Group's high three-year median payout ratio of 289% suggests that the company is depleting its resources to keep up its dividend payments, and this shows in its shrinking earnings. Paying a dividend beyond their means is usually not viable over the long term. You can see the 4 risks we have identified for Spark Infrastructure Group by visiting our risks dashboard for free on our platform here.

Moreover, Spark Infrastructure Group has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 294%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 4.4%.

Conclusion

On the whole, Spark Infrastructure Group's performance is quite a big let-down. The low ROE, combined with the fact that the company is paying out almost if not all, of its profits as dividends, has resulted in the lack or absence of growth in its earnings. That being so, the latest industry analyst forecasts show that analysts are forecasting a slight improvement in the company's future earnings growth. The company's existing shareholders might have some respite after all. 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.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.