Iberdrola, S.A. (BME:IBE) On An Uptrend: Could Fundamentals Be Driving The Stock?

Iberdrola's (BME:IBE) stock is up by 3.2% over the past month. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to investigate if the company's decent financials had a hand to play in the recent price move. In this article, we decided to focus on Iberdrola's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Iberdrola

How To 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:

9.0% = €5.4b ÷ €60b (Based on the trailing twelve months to June 2023).

The 'return' is the yearly profit. So, this means that for every €1 of its shareholder's investments, the company generates a profit of €0.09.

What Has ROE Got To Do With Earnings Growth?

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

A Side By Side comparison of Iberdrola's Earnings Growth And 9.0% ROE

When you first look at it, Iberdrola's ROE doesn't look that attractive. Next, when compared to the average industry ROE of 12%, the company's ROE leaves us feeling even less enthusiastic. Although, we can see that Iberdrola saw a modest net income growth of 8.3% over the past five years. So, the growth in the company's earnings could probably have been caused by other variables. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Iberdrola's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 7.9% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Iberdrola is trading on a high P/E or a low P/E, relative to its industry.

Is Iberdrola Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 76% (or a retention ratio of 24%) for Iberdrola suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Moreover, Iberdrola is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 69%. Regardless, the future ROE for Iberdrola is predicted to rise to 11% despite there being not much change expected in its payout ratio.

Conclusion

On the whole, we do feel that Iberdrola has some positive attributes. While no doubt its earnings growth is pretty substantial, we do feel that the reinvestment rate is pretty low, meaning, the earnings growth number could have been significantly higher had the company been retaining more of its profits. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.