Declining Stock and Decent Financials: Is The Market Wrong About Contact Energy Limited (NZSE:CEN)?

With its stock down 3.5% over the past month, it is easy to disregard Contact Energy (NZSE:CEN). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Contact Energy's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

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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 Contact Energy is:

12% = NZ$331m ÷ NZ$2.8b (Based on the trailing twelve months to June 2025).

The 'return' is the yearly profit. That means that for every NZ$1 worth of shareholders' equity, the company generated NZ$0.12 in profit.

See our latest analysis for Contact Energy

What Has ROE Got To Do With 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Contact Energy's Earnings Growth And 12% ROE

At first glance, Contact Energy seems to have a decent ROE. Even when compared to the industry average of 10% the company's ROE looks quite decent. This probably goes some way in explaining Contact Energy's moderate 13% growth over the past five years amongst other factors.

We then compared Contact Energy's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 8.8% in the same 5-year 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is CEN fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Contact Energy Using Its Retained Earnings Effectively?

Contact Energy's high three-year median payout ratio of 133% suggests that the company is paying out more to its shareholders than what it is making. 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. To know the 3 risks we have identified for Contact Energy visit our risks dashboard for free.

Additionally, Contact Energy 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. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 96% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.

Summary

Overall, we feel that Contact Energy certainly does have some positive factors to consider. Specifically, its high ROE which likely led to the growth in earnings. Bear in mind, the company reinvests little to none of its profits, which means that investors aren't necessarily reaping the full benefits of the high rate of return. 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 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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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.