Declining Stock and Solid Fundamentals: Is The Market Wrong About WEG S.A. (BVMF:WEGE3)?

It is hard to get excited after looking at WEG's (BVMF:WEGE3) recent performance, when its stock has declined 3.3% over the past month. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on WEG's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for WEG

How Do You Calculate Return On Equity?

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 WEG is:

33% = R$5.9b ÷ R$18b (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each R$1 of shareholders' capital it has, the company made R$0.33 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. 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.

WEG's Earnings Growth And 33% ROE

To begin with, WEG has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 8.4% which is quite remarkable. Under the circumstances, WEG's considerable five year net income growth of 28% was to be expected.

As a next step, we compared WEG's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 17%.

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 WEG is trading on a high P/E or a low P/E, relative to its industry.

Is WEG Making Efficient Use Of Its Profits?

WEG's significant three-year median payout ratio of 51% (where it is retaining only 49% of its income) suggests that the company has been able to achieve a high growth in earnings despite returning most of its income to shareholders.

Moreover, WEG is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 48%. As a result, WEG's ROE is not expected to change by much either, which we inferred from the analyst estimate of 29% for future ROE.

Conclusion

Overall, we are quite pleased with WEG's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.