Is Weakness In Ultrapar Participações S.A. (BVMF:UGPA3) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

Ultrapar Participações (BVMF:UGPA3) has had a rough month with its share price down 8.6%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Ultrapar Participações' ROE today.

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.

Check out our latest analysis for Ultrapar Participações

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 Ultrapar Participações is:

20% = R$3.0b ÷ R$15b (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. So, this means that for every R$1 of its shareholder's investments, the company generates a profit of R$0.20.

Why Is ROE Important For 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. 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.

A Side By Side comparison of Ultrapar Participações' Earnings Growth And 20% ROE

To begin with, Ultrapar Participações seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 20%. This probably goes some way in explaining Ultrapar Participações' significant 36% net income growth over the past five years amongst other factors. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Ultrapar Participações' 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 36% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Ultrapar Participações is trading on a high P/E or a low P/E, relative to its industry.

Is Ultrapar Participações Using Its Retained Earnings Effectively?

Ultrapar Participações' three-year median payout ratio is a pretty moderate 37%, meaning the company retains 63% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Ultrapar Participações is reinvesting its earnings efficiently.

Moreover, Ultrapar Participações 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 42% of its profits over the next three years. Still, forecasts suggest that Ultrapar Participações' future ROE will drop to 15% even though the the company's payout ratio is not expected to change by much.

Summary

On the whole, we feel that Ultrapar Participações' performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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. 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. 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.