Does The Market Have A Low Tolerance For Telefónica Deutschland Holding AG's (ETR:O2D) Mixed Fundamentals?

With its stock down 42% over the past three months, it is easy to disregard Telefónica Deutschland Holding (ETR:O2D). It seems that the market might have completely ignored the positive aspects of the company's fundamentals and decided to weigh-in more on the negative aspects. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. In this article, we decided to focus on Telefónica Deutschland Holding's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Telefónica Deutschland Holding

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 Telefónica Deutschland Holding is:

4.6% = €248m ÷ €5.4b (Based on the trailing twelve months to June 2023).

The 'return' is the amount earned after tax over the last twelve months. That means that for every €1 worth of shareholders' equity, the company generated €0.05 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

A Side By Side comparison of Telefónica Deutschland Holding's Earnings Growth And 4.6% ROE

On the face of it, Telefónica Deutschland Holding's ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 7.9% either. In spite of this, Telefónica Deutschland Holding was able to grow its net income considerably, at a rate of 57% in the last five years. Therefore, there could be other reasons behind this 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.

We then compared Telefónica Deutschland Holding's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 16% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. What is O2D worth today? The intrinsic value infographic in our free research report helps visualize whether O2D is currently mispriced by the market.

Is Telefónica Deutschland Holding Using Its Retained Earnings Effectively?

The really high three-year median payout ratio of 170% for Telefónica Deutschland Holding suggests that the company is paying its shareholders more than what it is earning. In spite of this, the company was able to grow its earnings significantly, as we saw above. Having said that, the high payout ratio is definitely risky and something to keep an eye on. Our risks dashboard should have the 2 risks we have identified for Telefónica Deutschland Holding.

Additionally, Telefónica Deutschland Holding has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 174%. Regardless, the future ROE for Telefónica Deutschland Holding is predicted to rise to 6.2% despite there being not much change expected in its payout ratio.

Conclusion

In total, we're a bit ambivalent about Telefónica Deutschland Holding's performance. While no doubt its earnings growth is pretty substantial, its ROE and earnings retention is quite poor. So while the company has managed to grow its earnings in spite of this, we are unconvinced if this growth could extend, especially during troubled times. 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. 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.