Algonquin Power & Utilities Corp.'s (TSE:AQN) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

With its stock down 13% over the past month, it is easy to disregard Algonquin Power & Utilities (TSE:AQN). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Algonquin Power & Utilities' 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Algonquin Power & Utilities

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Algonquin Power & Utilities is:

12% = US$728m ÷ US$6.0b (Based on the trailing twelve months to December 2020).

The 'return' is the yearly profit. That means that for every CA$1 worth of shareholders' equity, the company generated CA$0.12 in profit.

What Is The Relationship Between ROE And 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.

A Side By Side comparison of Algonquin Power & Utilities' Earnings Growth And 12% ROE

To begin with, Algonquin Power & Utilities seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 9.0%. This certainly adds some context to Algonquin Power & Utilities' exceptional 55% net income growth seen over the past five years. We reckon that there could also be other factors at play here. 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 Algonquin Power & Utilities' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 7.8%.

Earnings growth is an important metric to consider when valuing a stock. 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 AQN fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Algonquin Power & Utilities Making Efficient Use Of Its Profits?

Algonquin Power & Utilities has a significant three-year median payout ratio of 75%, meaning the company only retains 25% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.

Moreover, Algonquin Power & Utilities is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 85% of its profits over the next three years. Regardless, Algonquin Power & Utilities' ROE is speculated to decline to 9.1% despite there being no anticipated change in its payout ratio.

Conclusion

In total, we are pretty happy with Algonquin Power & Utilities' performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. 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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