Is Companhia de Saneamento Básico do Estado de São Paulo - SABESP's (BVMF:SBSP3) Recent Stock Performance Tethered To Its Strong Fundamentals?

Most readers would already be aware that Companhia de Saneamento Básico do Estado de São Paulo - SABESP's (BVMF:SBSP3) stock increased significantly by 16% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Companhia de Saneamento Básico do Estado de São Paulo - SABESP's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

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

27% = R$10b ÷ R$38b (Based on the trailing twelve months to March 2025).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every R$1 of its shareholder's investments, the company generates a profit of R$0.27.

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

What Has ROE Got To Do With 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.

Companhia de Saneamento Básico do Estado de São Paulo - SABESP's Earnings Growth And 27% ROE

To start with, Companhia de Saneamento Básico do Estado de São Paulo - SABESP's ROE looks acceptable. On comparing with the average industry ROE of 9.0% the company's ROE looks pretty remarkable. This probably laid the ground for Companhia de Saneamento Básico do Estado de São Paulo - SABESP's significant 36% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

Next, on comparing with the industry net income growth, we found that Companhia de Saneamento Básico do Estado de São Paulo - SABESP's growth is quite high when compared to the industry average growth of 12% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Has the market priced in the future outlook for SBSP3? You can find out in our latest intrinsic value infographic research report.

Is Companhia de Saneamento Básico do Estado de São Paulo - SABESP Using Its Retained Earnings Effectively?

Companhia de Saneamento Básico do Estado de São Paulo - SABESP has a three-year median payout ratio of 27% (where it is retaining 73% of its income) which is not too low or not too high. By the looks of it, the dividend is well covered and Companhia de Saneamento Básico do Estado de São Paulo - SABESP is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Additionally, Companhia de Saneamento Básico do Estado de São Paulo - SABESP has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 37% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 15%, over the same period.

Conclusion

Overall, we are quite pleased with Companhia de Saneamento Básico do Estado de São Paulo - SABESP's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.