Are VGP NV's (EBR:VGP) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

VGP (EBR:VGP) has had a rough three months with its share price down 9.4%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to VGP'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 VGP

How Is ROE Calculated?

ROE 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 VGP is:

8.6% = €194m ÷ €2.3b (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each €1 of shareholders' capital it has, the company made €0.09 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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 VGP's Earnings Growth And 8.6% ROE

When you first look at it, VGP's ROE doesn't look that attractive. However, the fact that the company's ROE is higher than the average industry ROE of 5.2%, is definitely interesting. However, VGP's five year net income decline rate was 19%. Bear in mind, the company does have a slightly low ROE. It is just that the industry ROE is lower. Hence, this goes some way in explaining the shrinking earnings.

As a next step, we compared VGP's performance with the industry and found thatVGP's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 5.6% in the same period, which is a slower than the company.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 VGP is trading on a high P/E or a low P/E, relative to its industry.

Is VGP Making Efficient Use Of Its Profits?

VGP's low three-year median payout ratio of 22% (or a retention ratio of 78%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. The low payout should mean that the company is retaining most of its earnings and consequently, should see some growth. So there could be some other explanations in that regard. For example, the company's business may be deteriorating.

Additionally, VGP has paid dividends over a period of seven years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 90% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 5.4%, over the same period.

Summary

In total, it does look like VGP has some positive aspects to its business. However, while the company does have a decent ROE and a high profit retention, its earnings growth number is quite disappointing. This suggests that there might be some external threat to the business, that's hampering growth. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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. 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.