Biomass Energy Project (WSE:BEP) has had a great run on the share market with its stock up by a significant 86% over the last three months. However, we wonder if the company’s inconsistent financials would have any adverse impact on the current share price momentum. In this article, we decided to focus on Biomass Energy Project’s ROE.
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.
How Do You Calculate Return On Equity?
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 Biomass Energy Project is:
3.2% = zł668k ÷ zł21m (Based on the trailing twelve months to June 2020).
The ‘return’ is the income the business earned over the last year. So, this means that for every PLN1 of its shareholder’s investments, the company generates a profit of PLN0.03.
Why Is ROE Important For 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.
A Side By Side comparison of Biomass Energy Project’s Earnings Growth And 3.2% ROE
As you can see, Biomass Energy Project’s ROE looks pretty weak. Even compared to the average industry ROE of 5.5%, the company’s ROE is quite dismal. For this reason, Biomass Energy Project’s five year net income decline of 54% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. Such as – low earnings retention or poor allocation of capital.
So, as a next step, we compared Biomass Energy Project’s performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 10% in the same period.
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. 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 Biomass Energy Project is trading on a high P/E or a low P/E, relative to its industry.
Is Biomass Energy Project Efficiently Re-investing Its Profits?
Because Biomass Energy Project doesn’t pay any dividends, we infer that it is retaining all of its profits, which is rather perplexing when you consider the fact that there is no earnings growth to show for it. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.
Overall, we have mixed feelings about Biomass Energy Project. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. To know the 4 risks we have identified for Biomass Energy Project visit our risks dashboard for free.
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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. 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.
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