EDP - Energias do Brasil S.A. (BVMF:ENBR3) On An Uptrend: Could Fundamentals Be Driving The Stock?

Most readers would already know that EDP - Energias do Brasil's (BVMF:ENBR3) stock increased by 9.9% over the past three months. As most would know, long-term fundamentals have a strong correlation with market price movements, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on EDP - Energias do Brasil's 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for EDP - Energias do Brasil

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 EDP - Energias do Brasil is:

14% = R$1.4b ÷ R$10b (Based on the trailing twelve months to March 2020).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every R$1 worth of equity, the company was able to earn R$0.14 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learnt that ROE is a measure of a company's profitability. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of EDP - Energias do Brasil's Earnings Growth And 14% ROE

On the face of it, EDP - Energias do Brasil's ROE is not much to talk about. However, its ROE is similar to the industry average of 14%, so we won't completely dismiss the company. Having said that, EDP - Energias do Brasil has shown a modest net income growth of 5.1% over the past five years. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that EDP - Energias do Brasil's reported growth was lower than the industry growth of 12% in the same period, which is not something we like to see.

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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if EDP - Energias do Brasil is trading on a high P/E or a low P/E, relative to its industry.

Is EDP - Energias do Brasil Making Efficient Use Of Its Profits?

EDP - Energias do Brasil has a three-year median payout ratio of 39%, which implies that it retains the remaining 61% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Besides, EDP - Energias do Brasil has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.

Summary

In total, it does look like EDP - Energias do Brasil has some positive aspects to its business. That is, a decent growth in earnings backed by a high rate of reinvestment. However, we do feel that that earnings growth could have been higher if the business were to improve on the low ROE rate. Especially given how the company is reinvesting a huge chunk of its profits. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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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