It is hard to get excited after looking at Spark Energy’s (NASDAQ:SPKE) recent performance, when its stock has declined 29% over the past three months. 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. Specifically, we decided to study Spark Energy’s ROE in this article.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. 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 Is ROE Calculated?
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:
9.0% = US$14m ÷ US$157m (Based on the trailing twelve months to December 2019).
The ‘return’ is the profit over the last twelve months. So, this means that for every $1 of its shareholder’s investments, the company generates a profit of $0.09.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learnt 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.
Spark Energy’s Earnings Growth And 9.0% ROE
When you first look at it, Spark Energy’s ROE doesn’t look that attractive. Yet, a closer study shows that the company’s ROE is similar to the industry average of 9.5%. Having said that, Spark Energy’s five year net income decline rate was 14%. Remember, the company’s ROE is a bit low to begin with. Therefore, the decline in earnings could also be the result of this.
However, when we compared Spark Energy’s growth with the industry we found that while the company’s earnings have been shrinking, the industry has seen an earnings growth of 7.3% in the same period. This is quite worrisome.
NasdaqGS:SPKE Past Earnings Growth April 24th 2020
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock’s future looks promising or ominous. If you’re wondering about Spark Energy’s’s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Spark Energy Using Its Retained Earnings Effectively?
With a high three-year median payout ratio of 84% (implying that 16% of the profits are retained), most of Spark Energy’s profits are being paid to shareholders, which explains the company’s shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely. To know the 5 risks we have identified for Spark Energy visit our risks dashboard for free.
Moreover, Spark Energy has been paying dividends for five years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking.
Conclusion
In total, we would have a hard think before deciding on any investment action concerning Spark Energy. As a result of its low ROE and lack of mich reinvestment into the business, the company has seen a disappointing earnings growth rate. 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.
If you spot an error that warrants correction, please contact the editor at editorial-team@simplywallst.com. 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. Simply Wall St has no position in the stocks mentioned.
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