Contact Energy's (NZSE:CEN) stock up by 1.9% over the past month. As most would know, long-term fundamentals have a strong correlation with market price movements, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Contact Energy's ROE.

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.

See our latest analysis for Contact 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 Contact Energy is:

9.0% = NZ$235m ÷ NZ$2.6b (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. That means that for every NZ$1 worth of shareholders' equity, the company generated NZ$0.09 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

Contact Energy's Earnings Growth And 9.0% ROE

On the face of it, Contact Energy's ROE is not much to talk about. However, the fact that the its ROE is quite higher to the industry average of 7.5% doesn't go unnoticed by us. This probably goes some way in explaining Contact Energy's moderate 5.0% growth over the past five years amongst other factors. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. So there might well be other reasons for the earnings to grow. Such as- high earnings retention or the company belonging to a high growth industry.

Next, on comparing Contact Energy's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 6.1% over the last few years.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Contact Energy's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Contact Energy Making Efficient Use Of Its Profits?

The really high three-year median payout ratio of 138% for Contact Energy suggests that the company is paying its shareholders more than what it is earning. In spite of this, the company was able to grow its earnings respectably, as we saw above. Although, the high payout ratio is certainly something we would keep an eye on if the company is not able to keep up its growth, or if business deteriorates.

Moreover, Contact Energy 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 91% over the next three years. As a result, the expected drop in Contact Energy's payout ratio explains the anticipated rise in the company's future ROE to 13%, over the same period.

Summary

Overall, we feel that Contact Energy certainly does have some positive factors to consider. Namely, its high earnings growth, which was probably achieved due to its respectable ROE. However, the considerably low reinvestment rate does diminish our excitement to a certain extent. On studying current analyst estimates, we found that analysts expect the company to continue its recent growth streak. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.