Befesa S.A.'s (ETR:BFSA) Dismal Stock Performance Reflects Weak Fundamentals

With its stock down 27% over the past three months, it is easy to disregard Befesa (ETR:BFSA). Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. In this article, we decided to focus on Befesa's ROE.

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.

Check out our latest analysis for Befesa

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 Befesa is:

7.2% = €56m ÷ €777m (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. So, this means that for every €1 of its shareholder's investments, the company generates a profit of €0.07.

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. 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 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 Befesa's Earnings Growth And 7.2% ROE

On the face of it, Befesa's ROE is not much to talk about. However, its ROE is similar to the industry average of 7.3%, so we won't completely dismiss the company. Having said that, Befesa's five year net income decline rate was 2.3%. Remember, the company's ROE is a bit low to begin with. So that's what might be causing earnings growth to shrink.

However, when we compared Befesa's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 26% in the same period. This is quite worrisome.

Earnings growth is a huge factor in stock valuation. 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. 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 Befesa is trading on a high P/E or a low P/E, relative to its industry.

Is Befesa Efficiently Re-investing Its Profits?

Befesa's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 51% (or a retention ratio of 49%). With only very little left to reinvest into the business, growth in earnings is far from likely. To know the 3 risks we have identified for Befesa visit our risks dashboard for free.

Moreover, Befesa has been paying dividends for seven years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 44% of its profits over the next three years. Still, forecasts suggest that Befesa's future ROE will rise to 10% even though the the company's payout ratio is not expected to change by much.

Summary

Overall, we would be extremely cautious before making any decision on Befesa. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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. 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.