Declining Stock and Solid Fundamentals: Is The Market Wrong About Enel Generación Chile S.A. (SNSE:ENELGXCH)?

With its stock down 3.7% over the past month, it is easy to disregard Enel Generación Chile (SNSE:ENELGXCH). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Enel Generación Chile's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Enel Generación Chile

How Is ROE Calculated?

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 Enel Generación Chile is:

20% = CL$493b ÷ CL$2.4t (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. Another way to think of that is that for every CLP1 worth of equity, the company was able to earn CLP0.20 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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 Enel Generación Chile's Earnings Growth And 20% ROE

To start with, Enel Generación Chile's ROE looks acceptable. Especially when compared to the industry average of 9.7% the company's ROE looks pretty impressive. This certainly adds some context to Enel Generación Chile's exceptional 34% 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. Such as - high earnings retention or an efficient management in place.

We then compared Enel Generación Chile's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 13% in the same 5-year period.

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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Enel Generación Chile's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Enel Generación Chile Making Efficient Use Of Its Profits?

Enel Generación Chile's three-year median payout ratio is a pretty moderate 27%, meaning the company retains 73% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Enel Generación Chile is reinvesting its earnings efficiently.

Moreover, Enel Generación Chile 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.

Conclusion

In total, we are pretty happy with Enel Generación Chile's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. You can see the 2 risks we have identified for Enel Generación Chile by visiting our risks dashboard for free on our platform here.

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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.