It is hard to get excited after looking at Telefônica Brasil's (BVMF:VIVT3) recent performance, when its stock has declined 10% over the past three months. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. Particularly, we will be paying attention to Telefônica Brasil's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
See our latest analysis for Telefônica Brasil
How Is ROE Calculated?
Return on equity 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:
8.0% = R$5.6b ÷ R$69b (Based on the trailing twelve months to September 2022).
The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each R$1 of shareholders' capital it has, the company made R$0.08 in profit.
Why Is ROE Important For 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. 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.
Telefônica Brasil's Earnings Growth And 8.0% ROE
It is quite clear that Telefônica Brasil's ROE is rather low. However, the fact that it is higher than the industry average of 6.7% makes us a bit more interested. But then again, seeing that Telefônica Brasil's five year net income shrunk at a rate of 4.2% in the past five years, makes us think again. Remember, the company's ROE is quite low to begin with, just that it is higher than the industry average. So that's what might be causing earnings growth to shrink.
So, as a next step, we compared Telefônica Brasil's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 13% in the same period.
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. This then helps them determine if the stock is placed for a bright or bleak future. What is VIVT3 worth today? The intrinsic value infographic in our free research report helps visualize whether VIVT3 is currently mispriced by the market.
Is Telefônica Brasil Making Efficient Use Of Its Profits?
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 90% (or a retention ratio of 9.8%). With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 2 risks we have identified for Telefônica Brasil by visiting our risks dashboard for free on our platform here.
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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 92%. Accordingly, forecasts suggest that Telefônica Brasil's future ROE will be 8.6% which is again, similar to the current ROE.
Summary
On the whole, Telefônica Brasil's performance is quite a big let-down. While its ROE is pretty moderate, the company is retaining very little of its profits, meaning very little of its profits are being reinvested into the business. This explains 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.