Spark Energy, Inc.'s (NASDAQ:SPKE) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

Spark Energy's (NASDAQ:SPKE) stock is up by a considerable 23% over the past month. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to Spark Energy's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Spark Energy

How Do You 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 Spark Energy is:

33% = US$59m ÷ US$177m (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.33 in profit.

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. 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. 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.

Spark Energy's Earnings Growth And 33% ROE

Firstly, we acknowledge that Spark Energy has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 9.4% which is quite remarkable. Needless to say, we are quite surprised to see that Spark Energy's net income shrunk at a rate of 3.5% over the past five years. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. These include low earnings retention or poor allocation of capital.

That being said, we compared Spark Energy'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 6.9% in the same period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Spark Energy fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Spark Energy Making Efficient Use Of Its Profits?

Spark Energy has a high three-year median payout ratio of 84% (that is, it is retaining 16% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only very little left to reinvest into the business, growth in earnings is far from likely. To know the 4 risks we have identified for Spark Energy visit our risks dashboard for free.

Additionally, Spark Energy has paid dividends over a period of six years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings.

Conclusion

On the whole, we do feel that Spark Energy has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. So far, we've only made a quick discussion around the company's earnings growth. To gain further insights into Spark Energy's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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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