Does Befesa S.A.'s (ETR:BFSA) Weak Fundamentals Mean That The Market Could Correct Its Share Price?

Most readers would already be aware that Befesa's (ETR:BFSA) stock increased significantly by 29% over the past three months. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. Particularly, we will be paying attention to Befesa's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

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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:

6.5% = €51m ÷ €777m (Based on the trailing twelve months to December 2024).

The 'return' is the yearly profit. That means that for every €1 worth of shareholders' equity, the company generated €0.07 in profit.

See our latest analysis for Befesa

What Is The Relationship Between ROE And 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 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.

Befesa's Earnings Growth And 6.5% ROE

On the face of it, Befesa's ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 7.0%. But Befesa saw a five year net income decline of 3.0% over the past five years. Remember, the company's ROE is a bit low to begin with. Hence, this goes some way in explaining the shrinking earnings.

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. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for BFSA? You can find out in our latest intrinsic value infographic research report.

Is Befesa Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 50% (implying that 50% of the profits are retained), most of Befesa's profits are being paid to shareholders, which explains the company's shrinking earnings. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. Our risks dashboard should have the 2 risks we have identified for Befesa.

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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 44%. Regardless, the future ROE for Befesa is predicted to rise to 10% despite there being not much change expected in its payout ratio.

Conclusion

On the whole, Befesa's performance is quite a big let-down. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. 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.