Is 2G Energy AG's(ETR:2GB) Recent Stock Performance Tethered To Its Strong Fundamentals?

2G Energy's (ETR:2GB) stock is up by a considerable 48% over the past month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study 2G Energy's ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

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 ÷ €68m (Based on the trailing twelve months to June 2020).

The 'return' is the income the business earned over the last year. So, this means that for every €1 of its shareholder's investments, the company generates a profit of €0.15.

What Has ROE Got To Do With 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. 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

At first glance, 2G Energy seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 14%. This probably goes some way in explaining 2G Energy's significant 28% net income growth over the past five years amongst other factors. However, there could also be other drivers behind this growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that 2G Energy's reported growth was lower than the industry growth of 44% in the same period, which is not something we like to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if 2G Energy is trading on a high P/E or a low P/E, relative to its industry.

Is 2G Energy Efficiently Re-investing Its Profits?

2G Energy has a three-year median payout ratio of 26% (where it is retaining 74% of its income) which is not too low or not too high. By the looks of it, the dividend is well covered and 2G Energy is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Besides, 2G Energy has been paying dividends over a period of nine years. This shows that the company is committed to sharing profits with its shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 17% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.

Conclusion

In total, we are pretty happy with 2G Energy's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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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