Iberdrola (BME:IBE) stock is up 22% in the past three months. Since stock prices are usually aligned with a company’s financial performance over the long term, we decided to take a closer look at its financial indicators to see if they had a role to play in the recent price movement. . In this article, we decided to focus on Iberdrola’s ROE.
ROE or return on equity is a useful tool for evaluating how effectively a company can generate returns on the investment it has received from its shareholders. In other words, it is a profitability ratio that measures the rate of return on capital contributed by the company’s shareholders.
See our latest analysis for Iberdrola
How to calculate return on equity?
the ROE formula is:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for Iberdrola is:
7.7% = €4.5 billion ÷ €58 billion (based on the last twelve months until March 2022).
“Yield” is the income the business has earned over the past year. One way to conceptualize this is that for every euro of share capital it has, the company has made a profit of 0.08 euro.
What is the relationship between ROE and earnings growth?
So far we have learned that ROE is a measure of a company’s profitability. Depending on how much of those earnings the company reinvests or “keeps”, and how efficiently it does so, we are then able to gauge a company’s earnings growth potential. Generally speaking, all things being equal, companies with high return on equity and earnings retention have a higher growth rate than companies that do not share these attributes.
A side-by-side comparison of Iberdrola’s earnings growth and 7.7% ROE
At first glance, Iberdrola’s ROE does not look very promising. Yet further investigation shows that the company’s ROE is similar to the industry average of 8.5%. That said, Iberdrola has posted modest net income growth of 6.7% over the past five years. Given the slightly weak ROE, it is likely that other factors could be driving this growth. For example, it is possible that the management of the company has made good strategic decisions or that the company has a low payout ratio.
We then compared Iberdrola’s net income growth with the industry and we are happy to see that the growth figure for the company is higher compared to the industry which has a growth rate of 3.3 % over the same period.
Earnings growth is an important factor in stock valuation. The investor should try to establish whether the expected growth or decline in earnings, as the case may be, is taken into account. By doing so, he will get an idea if the title is heading for clear blue waters or if swampy waters await. Is the IBE correctly valued? This intrinsic business value infographic has everything you need to know.
Is Iberdrola effectively using its retained earnings?
Iberdrola has a large three-year median payout ratio of 74%, which means it only has 26% left to reinvest in its business. This implies that the company was able to achieve decent earnings growth despite returning most of its earnings to shareholders.
Moreover, Iberdrola is determined to continue sharing its profits with shareholders, which we infer from its long history of paying dividends for at least ten years. After reviewing the latest analyst consensus data, we found that the company is expected to continue to pay out about 71% of its earnings over the next three years. Still, forecasts suggest that Iberdrola’s future ROE will reach 9.9%, even though the company’s payout ratio isn’t expected to change much.
Overall, we think Iberdrola certainly has some positives to consider. While its earnings growth is undoubtedly quite significant, we believe that the reinvestment rate is quite low, which means that the earnings growth figure could have been significantly higher had the company retained a greater part of its profits. We also studied the latest analyst forecasts and found that the company’s earnings growth is expected to be similar to its current growth rate. For more on the company’s future earnings growth forecast, check out this free analyst forecast report for the company to learn more.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.