Power Corporation of Canada (TSE:POW) has had a rough three months with its share price down 8.5%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Power Corporation of Canada's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How To Calculate Return On Equity?
Return on equity 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 Power Corporation of Canada is:
11% = CA$4.7b ÷ CA$43b (Based on the trailing twelve months to March 2022).
The 'return' is the profit over the last twelve months. Another way to think of that is that for every CA$1 worth of equity, the company was able to earn CA$0.11 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
Power Corporation of Canada's Earnings Growth And 11% ROE
To start with, Power Corporation of Canada's ROE looks acceptable. Even when compared to the industry average of 14% the company's ROE looks quite decent. This certainly adds some context to Power Corporation of Canada's moderate 18% net income growth seen over the past five years.
Next, on comparing Power Corporation of Canada's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 18% in the same period.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Power Corporation of Canada is trading on a high P/E or a low P/E, relative to its industry.
Is Power Corporation of Canada Using Its Retained Earnings Effectively?
The high three-year median payout ratio of 61% (or a retention ratio of 39%) for Power Corporation of Canada suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.
Moreover, Power Corporation of Canada 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.
In total, we are pretty happy with Power Corporation of Canada's performance. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.
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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.