Should Weakness in Spark New Zealand Limited's (NZSE:SPK) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

It is hard to get excited after looking at Spark New Zealand's (NZSE:SPK) recent performance, when its stock has declined 11% over the past three months. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Spark New Zealand's ROE.

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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Spark New Zealand

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 Spark New Zealand is:

26% = NZ$427m ÷ NZ$1.7b (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. Another way to think of that is that for every NZ$1 worth of equity, the company was able to earn NZ$0.26 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

Spark New Zealand's Earnings Growth And 26% ROE

To begin with, Spark New Zealand has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 5.2% which is quite remarkable. This likely paved the way for the modest 20% net income growth seen by Spark New Zealand over the past five years.

As a next step, we compared Spark New Zealand'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 20% 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. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for SPK? You can find out in our latest intrinsic value infographic research report.

Is Spark New Zealand Efficiently Re-investing Its Profits?

Spark New Zealand has a very high three-year median payout ratio of 113% suggesting that the company's shareholders are getting paid from more than just the company's earnings. Still the company's earnings have grown respectably. It would still be worth keeping an eye on that high payout ratio, if for some reason the company runs into problems and business deteriorates. Our risks dashboard should have the 3 risks we have identified for Spark New Zealand.

Additionally, Spark New Zealand 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 109%. As a result, Spark New Zealand's ROE is not expected to change by much either, which we inferred from the analyst estimate of 30% for future ROE.

Conclusion

Overall, we feel that Spark New Zealand certainly does have some positive factors to consider. Namely, its high earnings growth, which was likely due to its high ROE. However, investors could have benefitted even more from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining hardly any of its profits. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.