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Befesa's (ETR:BFSA) stock is up by a considerable 17% over the past month. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Particularly, we will be paying attention to Befesa's ROE today.
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.
Check out our latest analysis for Befesa
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Befesa is:
5.4% = €46m ÷ €846m (Based on the trailing twelve months to September 2023).
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 €0.05 in profit.
What Is The Relationship Between ROE And 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. 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.
Befesa's Earnings Growth And 5.4% ROE
At first glance, Befesa's ROE doesn't look very promising. However, its ROE is similar to the industry average of 6.7%, so we won't completely dismiss the company. On the other hand, Befesa reported a fairly low 3.6% net income growth over the past five years. Remember, the company's ROE is not particularly great to begin with. So this could also be one of the reasons behind the company's low growth in earnings.
Next, on comparing with the industry net income growth, we found that Befesa's reported growth was lower than the industry growth of 9.7% over the last few years, which is not something we like to see.
Earnings growth is a huge factor in stock valuation. 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 Befesa is trading on a high P/E or a low P/E, relative to its industry.