Should Weakness in Edison S.A.'s (WSE:EDN) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

Edison (WSE:EDN) has had a rough three months with its share price down 5.7%. 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 Edison'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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Edison

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Edison is:

24% = zł678k ÷ zł2.8m (Based on the trailing twelve months to September 2020).

The 'return' is the income the business earned over the last year. That means that for every PLN1 worth of shareholders' equity, the company generated PLN0.24 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. 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. 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.

Edison's Earnings Growth And 24% ROE

To begin with, Edison has a pretty high ROE which is interesting. Further, even comparing with the industry average if 24%, the company's ROE is quite respectable. Needless to say, we are quite surprised to see that Edison's net income shrunk at a rate of 21% over the past five years in spite of its decent. So, there might be some other aspects that could explain this. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

That being said, we compared Edison's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 17% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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 Edison fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Edison Efficiently Re-investing Its Profits?

Conclusion

On the whole, we do feel that Edison has some positive attributes. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard would have the 3 risks we have identified for Edison.

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This article by Simply Wall St is general in nature. 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.
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