Do Its Financials Have Any Role To Play In Driving Companhia de Saneamento Básico do Estado de São Paulo - SABESP's (BVMF:SBSP3) Stock Up Recently?

Most readers would already be aware that Companhia de Saneamento Básico do Estado de São Paulo - SABESP's (BVMF:SBSP3) stock increased significantly by 18% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to Companhia de Saneamento Básico do Estado de São Paulo - SABESP's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Companhia de Saneamento Básico do Estado de São Paulo - SABESP

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 Companhia de Saneamento Básico do Estado de São Paulo - SABESP is:

10% = R$3.0b ÷ R$30b (Based on the trailing twelve months to September 2023).

The 'return' is the income the business earned over the last year. That means that for every R$1 worth of shareholders' equity, the company generated R$0.10 in profit.

What Is The Relationship Between ROE And 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.

Companhia de Saneamento Básico do Estado de São Paulo - SABESP's Earnings Growth And 10% ROE

It is quite clear that Companhia de Saneamento Básico do Estado de São Paulo - SABESP's ROE is rather low. Further, we noted that the company's ROE is similar to the industry average of 11%. Thus, the low ROE certainly provides some context to Companhia de Saneamento Básico do Estado de São Paulo - SABESP's very little net income growth of 2.4% seen over the past five years.

When you consider the fact that the industry earnings have shrunk at a rate of 8.2% in the same 5-year period, the company's net income growth is pretty remarkable.

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. This then helps them determine if the stock is placed for a bright or bleak future. Is SBSP3 fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Companhia de Saneamento Básico do Estado de São Paulo - SABESP Efficiently Re-investing Its Profits?

Despite having a moderate three-year median payout ratio of 27% (implying that the company retains the remaining 73% of its income), Companhia de Saneamento Básico do Estado de São Paulo - SABESP's earnings growth was quite low. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

In addition, Companhia de Saneamento Básico do Estado de São Paulo - SABESP 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 25%. Regardless, the future ROE for Companhia de Saneamento Básico do Estado de São Paulo - SABESP is predicted to rise to 14% despite there being not much change expected in its payout ratio.

Summary

Overall, we feel that Companhia de Saneamento Básico do Estado de São Paulo - SABESP certainly does have some positive factors to consider. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.