Most readers would already be aware that AGL Energy's (ASX:AGL) stock increased significantly by 5.3% over the past week. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. In this article, we decided to focus on AGL Energy's  ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for AGL Energy

How Is ROE Calculated?

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 AGL Energy is:

6.9% = AU$378m ÷ AU$5.5b (Based on the trailing twelve months to December 2023).

The 'return' is the profit over the last twelve months. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.07.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

A Side By Side comparison of AGL Energy's Earnings Growth And 6.9% ROE

When you first look at it, AGL Energy's ROE doesn't look that attractive. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 10%. Therefore, it might not be wrong to say that the five year net income decline of 33% seen by AGL Energy was probably the result of it having a lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.



However, when we compared AGL 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 8.3% in the same period. This is quite worrisome. past-earnings-growth

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. This then helps them determine if the stock is placed for a bright or bleak future. Is AGL Energy fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is AGL Energy Efficiently Re-investing Its Profits?

AGL Energy has a high LTM (or last twelve month) payout ratio of 85% (that is, it is retaining 15% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. To know the 2 risks we have identified for AGL Energy visit our risks dashboard for free.

Additionally, AGL Energy has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 59% over the next three years. As a result, the expected drop in AGL Energy's payout ratio explains the anticipated rise in the company's future ROE to 9.3%, over the same period.

Summary

On the whole, AGL Energy's performance is quite a big let-down. 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. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. 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.