Rio Paranapanema Energia S.A.'s (BVMF:GEPA3) Stock Been Rising But Financials Look Weak: Should Shareholders Be Worried?

Most readers would already know that Rio Paranapanema Energia's (BVMF:GEPA3) stock increased by 3.4% over the past three months. Given that the markets usually pay for the long-term financial health of a company, we wonder if the current momentum in the share price will keep up, given that the company's financials don't look very promising. In this article, we decided to focus on Rio Paranapanema Energia's ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Rio Paranapanema Energia

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 Rio Paranapanema Energia is:

14% = R$242m ÷ R$1.8b (Based on the trailing twelve months to September 2020).

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$0.14 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

Rio Paranapanema Energia's Earnings Growth And 14% ROE

When you first look at it, Rio Paranapanema Energia's ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 16%, we may spare it some thought. Still, Rio Paranapanema Energia has seen a flat net income growth over the past five years. Bear in mind, the company's ROE is not very high. Hence, this provides some context to the flat earnings growth seen by the company.

We then compared Rio Paranapanema Energia's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 16% in the same period, which is a bit concerning.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is Rio Paranapanema Energia fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Rio Paranapanema Energia Using Its Retained Earnings Effectively?

While the company did pay out a portion of its dividend in the past, it currently doesn't pay a dividend. We infer that the company has been reinvesting all of its profits to grow its business.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Rio Paranapanema Energia. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. Up till now, we've only made a short study of the company's growth data. So it may be worth checking this free detailed graph of Rio Paranapanema Energia's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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This article by Simply Wall St is general in nature. 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.
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