Does The Market Have A Low Tolerance For GEA Group Aktiengesellschaft's (ETR:G1A) Mixed Fundamentals?

With its stock down 18% over the past three months, it is easy to disregard GEA Group (ETR:G1A). It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Specifically, we decided to study GEA Group'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for GEA Group

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 GEA Group is:

14% = €300m ÷ €2.1b (Based on the trailing twelve months to December 2021).

The 'return' is the income the business earned over the last year. That means that for every €1 worth of shareholders' equity, the company generated €0.14 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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.

GEA Group's Earnings Growth And 14% ROE

To begin with, GEA Group seems to have a respectable ROE. Especially when compared to the industry average of 11% the company's ROE looks pretty impressive. As you might expect, the 23% net income decline reported by GEA Group is a bit of a surprise. We reckon that there could be some other factors at play here that are preventing the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

As a next step, we compared GEA Group's performance with the industry and found thatGEA Group's performance is depressing even when compared with the industry, which has shrunk its earnings at a rate of 7.7% in the same period, which is a slower than the company.

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. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for G1A? You can find out in our latest intrinsic value infographic research report.

Is GEA Group Using Its Retained Earnings Effectively?

GEA Group's high three-year median payout ratio of 106% suggests that the company is depleting its resources to keep up its dividend payments, and this shows in its shrinking earnings. Paying a dividend higher than reported profits is not a sustainable move.

Moreover, GEA Group has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 51% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.

Conclusion

On the whole, we feel that the performance shown by GEA Group can be open to many interpretations. Despite the high ROE, the company has a disappointing earnings growth number, due to its poor rate of reinvestment into its business. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.