Should Weakness in EDP Renováveis, S.A.'s (ELI:EDPR) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

EDP Renováveis (ELI:EDPR) has had a rough three months with its share price down 11%. 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 EDP Renováveis' 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for EDP Renováveis

How To Calculate Return On Equity?

ROE 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 EDP Renováveis is:

3.6% = €459m ÷ €13b (Based on the trailing twelve months to December 2023).

The 'return' is the profit over the last twelve months. So, this means that for every €1 of its shareholder's investments, the company generates a profit of €0.04.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

A Side By Side comparison of EDP Renováveis' Earnings Growth And 3.6% ROE

When you first look at it, EDP Renováveis' ROE doesn't look that attractive. Next, when compared to the average industry ROE of 8.6%, the company's ROE leaves us feeling even less enthusiastic. However, the moderate 6.3% net income growth seen by EDP Renováveis over the past five years is definitely a positive. So, there might be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared EDP Renováveis' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 30% in the same 5-year period, which is a bit concerning.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if EDP Renováveis is trading on a high P/E or a low P/E, relative to its industry.

Is EDP Renováveis Using Its Retained Earnings Effectively?

EDP Renováveis has a low three-year median payout ratio of 16%, meaning that the company retains the remaining 84% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

Moreover, EDP Renováveis is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 38% over the next three years. However, EDP Renováveis' future ROE is expected to rise to 5.3% despite the expected increase in the company's payout ratio. We infer that there could be other factors that could be driving the anticipated growth in the company's ROE.

Summary

Overall, we feel that EDP Renováveis certainly does have some positive factors to consider. Specifically, its fairly high earnings growth number, which no doubt was backed by the company's high earnings retention. Still, the low ROE means that all that reinvestment is not reaping a lot of benefit to the investors. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.