Should Weakness in Companhia de Saneamento Básico do Estado de São Paulo - SABESP's (BVMF:SBSP3) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

With its stock down 8.7% over the past three months, it is easy to disregard Companhia de Saneamento Básico do Estado de São Paulo - SABESP (BVMF:SBSP3). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study Companhia de Saneamento Básico do Estado de São Paulo - SABESP's ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

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

How Do You 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:

5.5% = R$1.2b ÷ R$22b (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. Another way to think of that is that for every R$1 worth of equity, the company was able to earn R$0.06 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

A Side By Side comparison of Companhia de Saneamento Básico do Estado de São Paulo - SABESP's Earnings Growth And 5.5% ROE

It is hard to argue that Companhia de Saneamento Básico do Estado de São Paulo - SABESP's ROE is much good in and of itself. Not just that, even compared to the industry average of 9.3%, the company's ROE is entirely unremarkable. Companhia de Saneamento Básico do Estado de São Paulo - SABESP was still able to see a decent net income growth of 13% over the past five years. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place.

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 7.3% 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. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Companhia de Saneamento Básico do Estado de São Paulo - SABESP is trading on a high P/E or a low P/E, relative to its industry.

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

Companhia de Saneamento Básico do Estado de São Paulo - SABESP has a healthy combination of a moderate three-year median payout ratio of 29% (or a retention ratio of 71%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Besides, Companhia de Saneamento Básico do Estado de São Paulo - SABESP has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. 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 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. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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. 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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