Stock Analysis

# Is ERG S.p.A.'s (BIT:ERG) Stock Price Struggling As A Result Of Its Mixed Financials?

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ERG (BIT:ERG) has had a rough three months with its share price down 8.6%. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Stock prices are usually driven by a company’s financial performance over the long term, and therefore we decided to pay more attention to the company's financial performance. Particularly, we will be paying attention to ERG's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for ERG

## 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 ERG is:

15% = €280m ÷ €1.8b (Based on the trailing twelve months to September 2022).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every €1 worth of equity, the company was able to earn €0.15 in profit.

## What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

## ERG's Earnings Growth And 15% ROE

To start with, ERG's ROE looks acceptable. Even so, when compared with the average industry ROE of 20%, we aren't very excited. That being the case, the significant five-year 28% net income growth reported by ERG comes as a pleasant surprise. Therefore, there could be other causes behind this growth. Such as - high earnings retention or an efficient management in place. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this certainly also provides some context to the high earnings growth seen by the company.

Next, on comparing with the industry net income growth, we found that ERG's reported growth was lower than the industry growth of 43% in the same period, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. 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. If you're wondering about ERG's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

## Is ERG Using Its Retained Earnings Effectively?

The really high three-year median payout ratio of 103% for ERG 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. To know the 3 risks we have identified for ERG visit our risks dashboard for free.

Additionally, ERG 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 73% over the next three years. Regardless, the future ROE for ERG is predicted to decline to 10% despite the anticipated decrease in the payout ratio. We reckon that there could probably be other factors that could be driving the forseen decline in the company's ROE.

## Summary

On the whole, we feel that the performance shown by ERG can be open to many interpretations. Although the company has grown its earnings moderately as a result of its respectable ROE, yet, the business is retaining hardly any of its profits. This might have negative implications on the company's future growth prospects. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. 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.

### Valuation is complex, but we're helping make it simple.

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