2G Energy AG's (ETR:2GB) Stock Is Going Strong: Is the Market Following Fundamentals?

2G Energy's (ETR:2GB) stock is up by a considerable 55% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study 2G Energy'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for 2G Energy

How Do You Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for 2G Energy is:

15% = €10m ÷ €69m (Based on the trailing twelve months to December 2019).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every €1 worth of equity, the company was able to earn €0.15 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

2G Energy's Earnings Growth And 15% ROE

To start with, 2G Energy's ROE looks acceptable. Even when compared to the industry average of 15% the company's ROE looks quite decent. This certainly adds some context to 2G Energy's exceptional 20% 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. 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 2G Energy'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 an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about 2G Energy's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is 2G Energy Efficiently Re-investing Its Profits?

2G Energy's three-year median payout ratio is a pretty moderate 29%, meaning the company retains 71% of its income. So it seems that 2G Energy is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Moreover, 2G Energy is determined to keep sharing its profits with shareholders which we infer from its long history of eight years of paying a dividend. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 16% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.

Summary

In total, we are pretty happy with 2G Energy's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see a good amount of growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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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