Can Rio Paranapanema Energia S.A.'s (BVMF:GEPA3) Weak Financials Pull The Plug On The Stock's Current Momentum On Its Share Price?

Rio Paranapanema Energia (BVMF:GEPA3) has had a great run on the share market with its stock up by a significant 12% over the last three months. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimately dictates market outcomes. In this article, we decided to focus on Rio Paranapanema Energia'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.

Check out our latest analysis for Rio Paranapanema Energia

How To Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Rio Paranapanema Energia is:

14% = R$271m ÷ R$2.0b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each R$1 of shareholders' capital it has, the company made R$0.14 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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Rio Paranapanema Energia's Earnings Growth And 14% ROE

At first glance, Rio Paranapanema Energia's ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 16%. But Rio Paranapanema Energia saw a five year net income decline of 6.2% over the past five years. Remember, the company's ROE is a bit low to begin with. Therefore, the decline in earnings could also be the result of this.

However, when we compared Rio Paranapanema Energia's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 2.7% in the same period. This is quite worrisome.

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. If you're wondering about Rio Paranapanema Energia's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Rio Paranapanema Energia Making Efficient Use Of Its Profits?

Rio Paranapanema Energia's very high three-year median payout ratio of 116% over the last three years suggests that the company is paying its shareholders more than what it is earning and this explains the company's shrinking earnings. Paying a dividend higher than reported profits is not a sustainable move. To know the 3 risks we have identified for Rio Paranapanema Energia visit our risks dashboard for free.

In addition, Rio Paranapanema Energia has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Summary

In total, we would have a hard think before deciding on any investment action concerning Rio Paranapanema Energia. Specifically, it has shown quite an unsatisfactory performance as far as earnings growth is concerned, and a poor ROE and an equally poor rate of reinvestment seem to be the reason behind this inadequate performance. So far, we've only made a quick discussion around the company's earnings growth. To gain further insights into Rio Paranapanema Energia's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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.