Weak Financial Prospects Seem To Be Dragging Down Ebro Foods, S.A. (BME:EBRO) Stock

It is hard to get excited after looking at Ebro Foods' (BME:EBRO) recent performance, when its stock has declined 8.7% over the past three months. To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. Particularly, we will be paying attention to Ebro Foods' ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Ebro Foods

How Do You Calculate Return On Equity?

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 Ebro Foods is:

8.6% = €189m ÷ €2.2b (Based on the trailing twelve months to September 2023).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every €1 worth of equity, the company was able to earn €0.09 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

Ebro Foods' Earnings Growth And 8.6% ROE

At first glance, Ebro Foods' ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 9.1%, we may spare it some thought. Having said that, Ebro Foods' net income growth over the past five years is more or less flat. Remember, the company's ROE is not particularly great to begin with. Hence, this provides some context to the flat earnings growth seen by the company.

As a next step, we compared Ebro Foods' net income growth with the industry and discovered that the industry saw an average growth of 7.8% in the same 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. Doing so will help them establish if the stock's future looks promising or ominous. What is EBRO worth today? The intrinsic value infographic in our free research report helps visualize whether EBRO is currently mispriced by the market.

Is Ebro Foods Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 71% (implying that the company keeps only 29% of its income) of its business to reinvest into its business), most of Ebro Foods' profits are being paid to shareholders, which explains the absence of growth in earnings.

In addition, Ebro Foods has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 55% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Ebro Foods. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. 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. 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.