With its stock down 12% over the past three months, it is easy to disregard Pembina Pipeline (TSE:PPL). We, however decided to study the company’s financials to determine if they have got anything to do with the price decline. Fundamentals usually dictate market outcomes so it makes sense to study the company’s financials. Specifically, we decided to study Pembina Pipeline’s ROE in this article.
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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Do You Calculate Return On Equity?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for Pembina Pipeline is:
6.4% = CA$1.1b ÷ CA$17b (Based on the trailing twelve months to June 2020).
The ‘return’ refers to a company’s earnings 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$0.06 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we’ve learned that ROE is a measure of a company’s profitability. 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 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 Pembina Pipeline’s Earnings Growth And 6.4% ROE
On the face of it, Pembina Pipeline’s ROE is not much to talk about. However, its ROE is similar to the industry average of 8.0%, so we won’t completely dismiss the company. Moreover, we are quite pleased to see that Pembina Pipeline’s net income grew significantly at a rate of 32% over the last five years. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. For instance, the company has a low payout ratio or is being managed efficiently.
As a next step, we compared Pembina Pipeline’s net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 34% 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. Doing so will help them establish if the stock’s future looks promising or ominous. Has the market priced in the future outlook for PPL? You can find out in our latest intrinsic value infographic research report.
Is Pembina Pipeline Using Its Retained Earnings Effectively?
The high three-year median payout ratio of 100% (implying that it keeps only -0.5% of profits) for Pembina Pipeline suggests that the company’s growth wasn’t really hampered despite it returning most of the earnings to its shareholders.
Besides, Pembina Pipeline 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 is expected to keep paying out approximately 106% of its profits over the next three years. However, Pembina Pipeline’s ROE is predicted to rise to 8.9% despite there being no anticipated change in its payout ratio.
Overall, we have mixed feelings about Pembina Pipeline. Although the company has shown a pretty impressive growth in earnings, yet the low ROE and the low rate of reinvestment makes us skeptical about the continuity of that growth, especially when or if the business comes to face any threats. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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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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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