Gelsenwasser AG (FRA:WWG) had a decent run in the stock market: are the fundamentals in charge?

Most readers will already know that Gelsenwasser (FRA:WWG) stock is up 2.1% over the past month. Since stock prices are generally aligned with a company’s financial performance over the long term, we decided to investigate whether the company’s decent financials had a role to play in the recent price movement. In this article, we have decided to focus on Gelsenwasser’s ROE.

ROE or return on equity is a useful tool for evaluating how effectively a company can generate returns on the investment it has received from its shareholders. In other words, it reveals the company’s success in turning shareholders’ investments into profits.

See our latest analysis for Gelsenwasser

How do you calculate return on equity?

ROE can be calculated using the formula:

Return on equity = Net income (from continuing operations) ÷ Equity

So, based on the above formula, the ROE for Gelsenwasser is:

10% = €84m ÷ €804m (based on the last twelve months to June 2021).

“Yield” refers to a company’s earnings over the past year. This therefore means that for each €1 of investment by its shareholder, the company generates a profit of €0.10.

What does ROE have to do with earnings growth?

We have already established that ROE serves as an effective earnings-generating indicator for a company’s future earnings. Depending on how much of those earnings the company reinvests or “keeps”, and how efficiently it does so, we are then able to assess a company’s earnings growth potential. Assuming everything else remains unchanged, the higher the ROE and earnings retention, the higher a company’s growth rate compared to companies that don’t necessarily exhibit these characteristics.

A side-by-side comparison of Gelsenwasser’s earnings growth and 10% ROE

For starters, Gelsenwasser’s ROE looks acceptable. Still, the fact that the company’s ROE is 20% below the industry average tempers our expectations. After further research, we found that Gelsenwasser’s income over the past five years was quite stable. Keep in mind that the company has a respectable level of ROE. It’s just that the industry’s ROE is higher. Therefore, other factors could be behind the steady revenue growth. For example, the company pays a large portion of its profits in the form of dividends or faces competitive pressures.

As a next step, we compared Gelsenwasser’s net income growth with the industry and found that the company has a similar growth figure compared to the industry average growth rate of 1.0% during of the same period.

Earnings growth is an important metric to consider when evaluating a stock. The investor should try to establish whether the expected growth or decline in earnings, as the case may be, is taken into account. This then helps them determine whether the stock is set for a bright or bleak future. A 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 outlook. So, you might want to check if Gelsenwasser is trading on a high P/E or a low P/E, relative to its industry.

Does Gelsenwasser effectively reinvest its profits?

With a high three-year median payout ratio of 67% (implying that the company retains only 33% of its revenue) from its business to reinvest in its business), most of Gelsenwasser’s profits go to shareholders, which explains the lack of revenue growth.

Moreover, Gelsenwasser has been paying dividends for at least a decade or more, suggesting that management must have perceived that shareholders preferred dividends to earnings growth.

Conclusion

All in all, we think Gelsenwasser definitely has some positives to consider. Its profits grew respectably as we saw earlier, which was probably achieved by the company reinvesting its profits at a decent rate of return. Yet its earnings retention is quite low, so one wonders if the company’s growth could be higher, if it were to pay out fewer dividends and retain more of its earnings? So far, we’ve only scratched the surface of the company’s past performance by looking at the company’s fundamentals. You can do your own research on Gelsenwasser and see how it has performed in the past by watching this FREE detailed graph past profits, revenue and cash flow.

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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts only using unbiased methodology and our articles are not intended to be financial advice. It is not a recommendation to buy or sell stocks and does not take into account your objectives or financial situation. Our goal is to bring you targeted long-term analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price-sensitive companies or qualitative materials. Simply Wall St has no position in the stocks mentioned.