Telefônica Brasil S.A.'s (BVMF:VIVT3) Stock's Been Going Strong: Could Weak Financials Mean The Market Will Correct Its Share Price?

Telefônica Brasil's (BVMF:VIVT3) stock is up by a considerable 21% over the past three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. In this article, we decided to focus on Telefônica Brasil's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Telefônica Brasil

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 Telefônica Brasil is:

7.5% = R$5.2b ÷ R$69b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. Another way to think of that is that for every R$1 worth of equity, the company was able to earn R$0.08 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Telefônica Brasil's Earnings Growth And 7.5% ROE

It is hard to argue that Telefônica Brasil's ROE is much good in and of itself. Further, we noted that the company's ROE is similar to the industry average of 8.5%. Given the circumstances, the significant decline in net income by 2.6% seen by Telefônica Brasil over the last five years is not surprising.

However, when we compared Telefônica Brasil's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 30% in the same period. This is quite worrisome.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is VIVT3 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Telefônica Brasil Using Its Retained Earnings Effectively?

Telefônica Brasil's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 70% (or a retention ratio of 30%). With only a little being reinvested into the business, earnings growth would obviously be low or non-existent.

Additionally, Telefônica Brasil has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 94% over the next three years. Still, forecasts suggest that Telefônica Brasil's future ROE will rise to 11% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.

Summary

In total, we would have a hard think before deciding on any investment action concerning Telefônica Brasil. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. 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.