Befesa (ETR:BFSA) has had a rough three months with its share price down 32%. We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. Particularly, we will be paying attention to Befesa's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. 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 Befesa

How To Calculate Return On Equity?

ROE 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 Befesa is:

7.2% = €56m ÷ €777m (Based on the trailing twelve months to September 2024).

The 'return' is the yearly profit. So, this means that for every €1 of its shareholder's investments, the company generates a profit of €0.07.

What Has ROE Got To Do With 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.

Befesa's Earnings Growth And 7.2% ROE

At first glance, Befesa's ROE doesn't look very promising. However, its ROE is similar to the industry average of 7.3%, so we won't completely dismiss the company. But Befesa saw a five year net income decline of 2.3% over the past five years. Bear in mind, the company does have a slightly low ROE. Hence, this goes some way in explaining the shrinking earnings.

However, when we compared Befesa's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 26% in the same period. This is quite worrisome.

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. Is Befesa fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Befesa Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 51% (implying that 49% of the profits are retained), most of Befesa's profits are being paid to shareholders, which explains the company's shrinking earnings. The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run. Our risks dashboard should have the 3 risks we have identified for Befesa.

Additionally, Befesa has paid dividends over a period of seven years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 44% of its profits over the next three years. Still, forecasts suggest that Befesa's future ROE will rise to 10% even though the the company's payout ratio is not expected to change by much.

Summary

In total, we would have a hard think before deciding on any investment action concerning Befesa. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings 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.

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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.