Quanta Services, Inc.'s (NYSE:PWR) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

Quanta Services (NYSE:PWR) has had a rough month with its share price down 7.1%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Quanta Services' ROE in this article.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Quanta Services

How To 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 Quanta Services is:

12% = US$831m ÷ US$7.1b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.12 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Quanta Services' Earnings Growth And 12% ROE

To start with, Quanta Services' ROE looks acceptable. Be that as it may, the company's ROE is still quite lower than the industry average of 18%. However, the moderate 16% net income growth seen by Quanta Services over the past five years is definitely a positive. Therefore, the growth in earnings could probably have been caused by other variables. For instance, the company has a low payout ratio or is being managed efficiently. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this also does lend some color to the fairly high earnings growth seen by the company.

As a next step, we compared Quanta Services' 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 16% 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. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for PWR? You can find out in our latest intrinsic value infographic research report.

Is Quanta Services Efficiently Re-investing Its Profits?

In Quanta Services' case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 7.2% (or a retention ratio of 93%), which suggests that the company is investing most of its profits to grow its business.

Moreover, Quanta Services is determined to keep sharing its profits with shareholders which we infer from its long history of six years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 3.5% over the next three years. Regardless, the ROE is not expected to change much for the company despite the lower expected payout ratio.

Conclusion

On the whole, we feel that Quanta Services' performance has been quite good. In particular, it's great to see that the company has seen significant growth in its earnings backed by a respectable ROE and a high reinvestment rate. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.