Are Poor Financial Prospects Dragging Down Energiedienst Holding AG (VTX:EDHN Stock?

Energiedienst Holding (VTX:EDHN) has had a rough three months with its share price down 5.0%. To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. Specifically, we decided to study Energiedienst Holding's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Energiedienst Holding

How Do You Calculate Return On Equity?

Return on equity can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Energiedienst Holding is:

1.4% = €9.8m ÷ €707m (Based on the trailing twelve months to December 2019).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every CHF1 worth of equity, the company was able to earn CHF0.01 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learnt 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 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.

Energiedienst Holding's Earnings Growth And 1.4% ROE

As you can see, Energiedienst Holding's ROE looks pretty weak. Not just that, even compared to the industry average of 8.5%, the company's ROE is entirely unremarkable. Given the circumstances, the significant decline in net income by 25% seen by Energiedienst Holding over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

That being said, we compared Energiedienst Holding's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 8.3% in the same period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is EDHN fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Energiedienst Holding Making Efficient Use Of Its Profits?

Energiedienst Holding's very high three-year median payout ratio of 115% over the last three years suggests that the company is paying its shareholders more than what it is earning and this explains the company's shrinking earnings. Its usually very hard to sustain dividend payments that are higher than reported profits. You can see the 3 risks we have identified for Energiedienst Holding by visiting our risks dashboard for free on our platform here.

Moreover, Energiedienst Holding 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 59% over the next three years. The fact that the company's ROE is expected to rise to 7.1% over the same period is explained by the drop in the payout ratio.

Summary

On the whole, Energiedienst Holding's performance is quite a big let-down. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.

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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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