Should Weakness in Aquila SA's (EPA:ALAQU) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

With its stock down 22% over the past three months, it is easy to disregard Aquila (EPA:ALAQU). 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. In this article, we decided to focus on Aquila's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Aquila

How To 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 Aquila is:

16% = €597k ÷ €3.6m (Based on the trailing twelve months to December 2023).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each €1 of shareholders' capital it has, the company made €0.16 in profit.

What Is The Relationship Between ROE And 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. 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.

Aquila's Earnings Growth And 16% ROE

To start with, Aquila's ROE looks acceptable. On comparing with the average industry ROE of 12% the company's ROE looks pretty remarkable. For this reason, Aquila's five year net income decline of 3.8% raises the question as to why the high ROE didn't translate into earnings growth. Therefore, there might be some other aspects that could explain this. These include low earnings retention or poor allocation of capital.

However, when we compared Aquila's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 24% in the same period. This is quite worrisome.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Is Aquila fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Aquila Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 83% (implying that 17% of the profits are retained), most of Aquila's profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. You can see the 3 risks we have identified for Aquila by visiting our risks dashboard for free on our platform here.

Moreover, Aquila has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

In total, it does look like Aquila has some positive aspects to its business. However, while the company does have a high ROE, its earnings growth number is quite disappointing. This can be blamed on the fact that it reinvests only a small portion of its profits and pays out the rest as dividends. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. To gain further insights into Aquila's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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.