Compañía Eléctrica del Litoral S.A.'s (SNSE:LITORAL) Financials Look Varied: Is That The Reason For Its Muted Performance Recently?

Compañía Eléctrica del Litoral's (SNSE:LITORAL) stock was mostly flat over the past week. Looking at its differing financials, we wonder if the market is focusing more on the company's negatives than on the positives resulting in the stock's drab performance. Particularly, we will be paying attention to Compañía Eléctrica del Litoral's ROE today.

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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Compañía Eléctrica del Litoral

How Is ROE Calculated?

Return on equity 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 Compañía Eléctrica del Litoral is:

5.3% = CL$860m ÷ CL$16b (Based on the trailing twelve months to September 2020).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every CLP1 worth of equity, the company was able to earn CLP0.05 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. 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.

Compañía Eléctrica del Litoral's Earnings Growth And 5.3% ROE

As you can see, Compañía Eléctrica del Litoral's ROE looks pretty weak. Even compared to the average industry ROE of 11%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 11% seen by Compañía Eléctrica del Litoral was possibly a result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

Next, when we compared with the industry, which has shrunk its earnings at a rate of 1.7% in the same period, we still found Compañía Eléctrica del Litoral's performance to be quite bleak, because the company has been shrinking its earnings faster than the industry.

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 Compañía Eléctrica del Litoral's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Compañía Eléctrica del Litoral Using Its Retained Earnings Effectively?

Looking at its three-year median payout ratio of 32% (or a retention ratio of 68%) which is pretty normal, Compañía Eléctrica del Litoral's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

In addition, Compañía Eléctrica del Litoral has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Summary

On the whole, we feel that the performance shown by Compañía Eléctrica del Litoral can be open to many interpretations. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. To know the 3 risks we have identified for Compañía Eléctrica del Litoral visit our risks dashboard for free.

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