EnerSys' (NYSE:ENS) stock is up by a considerable 17% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Specifically, we decided to study EnerSys' ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How To Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for EnerSys is:
6.7% = US$97m ÷ US$1.4b (Based on the trailing twelve months to October 2020).
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 $0.07.
Why Is ROE Important For 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. 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.
A Side By Side comparison of EnerSys' Earnings Growth And 6.7% ROE
When you first look at it, EnerSys' ROE doesn't look that attractive. However, given that the company's ROE is similar to the average industry ROE of 7.3%, we may spare it some thought. However, EnerSys has seen a flattish net income growth over the past five years, which is not saying much. Remember, the company's ROE is not particularly great to begin with. Hence, this provides some context to the flat earnings growth seen by the company.
As a next step, we compared EnerSys' net income growth with the industry and discovered that the industry saw an average growth of 6.4% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. 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 EnerSys is trading on a high P/E or a low P/E, relative to its industry.
Is EnerSys Making Efficient Use Of Its Profits?
EnerSys' low three-year median payout ratio of 23%, (meaning the company retains77% of profits) should mean that the company is retaining most of its earnings and consequently, should see higher growth than it has reported.
Additionally, EnerSys has paid dividends over a period of eight years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.
On the whole, we feel that the performance shown by EnerSys can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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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