With its stock down 11% over the past three months, it is easy to disregard Iberdrola (BME:IBE). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study Iberdrola's ROE in this article.
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.
How Do You Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Iberdrola is:
7.3% = €3.7b ÷ €51b (Based on the trailing twelve months to June 2021).
The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every €1 worth of equity, the company was able to earn €0.07 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Iberdrola's Earnings Growth And 7.3% ROE
On the face of it, Iberdrola's ROE is not much to talk about. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 11%. However, the moderate 6.5% net income growth seen by Iberdrola over the past five years is definitely a positive. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place.
Next, on comparing with the industry net income growth, we found that Iberdrola's growth is quite high when compared to the industry average growth of 0.002% in the same period, which is great to see.
Earnings growth is an important metric to consider when valuing a stock. 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. Has the market priced in the future outlook for IBE? You can find out in our latest intrinsic value infographic research report.
Is Iberdrola Using Its Retained Earnings Effectively?
Iberdrola has a significant three-year median payout ratio of 75%, meaning that it is left with only 25% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.
Besides, Iberdrola has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its 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 72%. Still, forecasts suggest that Iberdrola's future ROE will rise to 10% even though the the company's payout ratio is not expected to change by much.
On the whole, we do feel that Iberdrola has some positive attributes. Namely, its high earnings growth. We do however feel that the earnings growth number could have been even higher, had the company been reinvesting more of its earnings and paid out less dividends. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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