Pembina Pipeline's (TSE:PPL) stock is up by a considerable 17% over the past three months. However, in this article, we decided to focus on its weak fundamentals, as long-term financial performance of a business is what ultimatley dictates market outcomes. Specifically, we decided to study Pembina Pipeline'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.
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 Pembina Pipeline is:
6.1% = CA$1.0b ÷ CA$17b (Based on the trailing twelve months to September 2020).
The 'return' is the income the business earned over the last year. So, this means that for every CA$1 of its shareholder's investments, the company generates a profit of CA$0.06.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.
Pembina Pipeline's Earnings Growth And 6.1% ROE
When you first look at it, Pembina Pipeline's ROE doesn't look that attractive. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 8.1%. In spite of this, Pembina Pipeline was able to grow its net income considerably, at a rate of 28% in the last five years. Therefore, there could be other reasons behind this 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.
As a next step, we compared Pembina Pipeline's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 39% in the same period.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for PPL? You can find out in our latest intrinsic value infographic research report.
Is Pembina Pipeline Using Its Retained Earnings Effectively?
The high three-year median payout ratio of 100% (implying that it keeps only -0.5% of profits) for Pembina Pipeline suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.
Besides, Pembina Pipeline 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 110%. Regardless, the future ROE for Pembina Pipeline is predicted to rise to 9.3% despite there being not much change expected in its payout ratio.
In total, we would have a hard think before deciding on any investment action concerning Pembina Pipeline. While no doubt its earnings growth is pretty respectable, its ROE and earnings retention is quite poor. So while the company has managed to grow its earnings in spite of this, we are unconvinced if this growth could extend, specially during troubled times. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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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