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Seplat Energy Plc (LON:SEPL) is on the rise but the financial outlook looks weak: is the stock overvalued?
Seplat Energy (LON:SEPL) has had a great run on the stock market with its shares up a significant 26% in the last three months. However, we wanted to take a closer look at its key financial indicators as markets often pay attention to long-term fundamentals and in this case they don’t look too promising. In particular, we’ll be paying attention to Seplat Energy ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess a company’s profitability relative to its equity.
Check out our latest analysis for Seplat Energy
How to calculate return on equity?
O formula for return on equity It is:
Return on Equity = Net Income (from continuing operations) ÷ Equity
Therefore, based on the above formula, Seplat Energy’s ROE is:
5.1% = US$91 million ÷ US$1.8 billion (based on the last twelve months to June 2024).
The “return” refers to a company’s profits over the last year. Another way to think of it is that for every £1 of equity, the company managed to earn £0.05 in profit.
What does ROE have to do with earnings growth?
We have already established that ROE serves as an efficient indicator of a company’s future earnings. Depending on how much of these earnings 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 a higher return on equity and higher earnings retention are generally those that have a higher growth rate when compared to companies that do not have the same characteristics.
A side-by-side comparison of Seplat Energy’s earnings growth and 5.1% ROE
At first glance, Seplat Energy’s ROE doesn’t look very promising. Then, when compared to the industry average ROE of 9.2%, the company’s ROE leaves us even less enthusiastic. Therefore, it may not be wrong to say that the 21% decline in five-year net income seen by Seplat Energy was probably a result of having a lower ROE. We think there could be other factors at play here as well. Like – low earnings retention or poor capital allocation.
So, as a next step, we compared Seplat Energy’s performance with that of the industry and were disappointed to find that while the company had been reducing its profits, the industry had been growing its profits at a rate of 24% in recent years.
past-earnings-growth
Earnings growth is an important metric to consider when evaluating a stock. An investor should try to establish whether the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea of whether the stock is headed for clear blue waters or if swampy waters await. 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 prospects. So, you may want to check if Seplat Energy is trading at a high or low P/Ein relation to your sector.
The story continues
Is Seplat Energy using its retained earnings effectively?
Seplat Energy has a high three-year median payout ratio of 85% (i.e. it is retaining 15% of its profits). This suggests that the company is paying out most of its profits as dividends to its shareholders. This partly explains why its profits have been declining. With only a small amount being reinvested into the business, earnings growth would obviously be low or non-existent.
Furthermore, Seplat Energy has been paying dividends for at least ten years or more, suggesting that management must have realized that shareholders prefer dividends to earnings growth. Our latest analyst data shows that the company’s future payout ratio is expected to fall to 65% in the next three years.
Conclusion
Overall, Seplat Energy’s performance is a major disappointment. As a result of its low ROE and lack of much reinvestment in the business, the company has seen a disappointing earnings growth rate. As such, the latest industry analyst forecasts show that analysts are expecting to see a major improvement in the company’s earnings growth rate. To learn more about the company’s future earnings growth forecasts, check out this free report analysts’ forecasts so the company knows more.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your objectives or financial situation. Our aim is to bring you long-term focused analysis, driven by fundamental data. Please note that our analysis may not take into account the latest price-sensitive company announcements or qualitative material. Simply Wall St has no position in any stocks mentioned.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, send an email editorial-team@simplywallst.com