The fundamentals of Schneider Electric SE (EPA:SU) look quite solid: could the market be wrong about the stock?

Schneider Electric (EPA:SU) had a tough three months with its share price down 15%. But if you pay close attention, you might find that its leading financial indicators look pretty decent, which could mean the stock could potentially rise in the long run as markets generally reward more resilient long-term fundamentals. In this article, we decided to focus on the ROE of Schneider Electric.

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 simpler terms, it measures a company’s profitability relative to equity.

Discover our latest analysis for Schneider Electric

How do you calculate return on equity?

The return on equity formula is as follows:

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

So, based on the above formula, Schneider Electric’s ROE is:

12% = €3.3 billion ÷ €28 billion (based on the last twelve months until December 2021).

The “yield” is the profit of the last twelve months. One way to conceptualize this is that for every €1 of share capital it has, the company has made a profit of €0.12.

Why is ROE important for earnings growth?

So far, we have learned that ROE measures how efficiently a company generates its profits. Depending on how much of those earnings the company reinvests or “keeps”, and how effectively it does so, we are then able to gauge a company’s earnings growth potential. Generally speaking, all things being equal, companies with high return on equity and earnings retention have a higher growth rate than companies that do not share these attributes.

Profit growth and 12% ROE for Schneider Electric

For starters, Schneider Electric’s ROE seems acceptable. Still, the fact that the company’s ROE is below the industry average of 16% tempers our expectations. Schneider Electric was still able to post a decent growth in net profit of 7.6% over the past five years. Thus, there could be other aspects that positively influence earnings growth. For example, it is possible that the management of the company has made good strategic decisions or that the company has a low payout ratio. However, it’s worth remembering that the company has a decent ROE to start with, just that it’s below the industry average. So this also provides some context for the earnings growth the company is seeing.

Then, comparing with the net income growth of the sector, we found that Schneider Electric’s growth is quite high compared to the sector’s average growth of 4.5% over the same period, which is great to to see.

The basis for attaching value to a company is, to a large extent, linked to the growth of its profits. It is important for an investor to know whether the market has priced in the expected growth (or decline) in the company’s earnings. This will help them determine if the future of the title looks bright or ominous. What is SU worth today? The intrinsic value infographic in our free research report visualizes whether the SU is currently being mispriced by the market.

Is Schneider Electric using its profits efficiently?

The high three-year median payout rate of 57% (or a retention rate of 43%) for Schneider Electric suggests that the company’s growth hasn’t really been hindered despite the fact that it donates most of its income to its shareholders.

Additionally, Schneider Electric is committed to continuing to share its profits with its shareholders, which we infer from its long history of paying dividends for at least ten years. After reviewing the latest analyst consensus data, we found that the company’s future payout ratio is expected to drop to 42% over the next three years. Thus, the expected decline in the payout rate explains the expected increase in the company’s ROE to 16%, over the same period.

Summary

Overall, we believe that Schneider Electric has positive strengths. Specifically, its respectable ROE which likely led to the considerable earnings growth. Yet the company retains a small portion of its profits. Which means the company was able to increase its profits despite this, so it’s not that bad. That said, looking at current analyst estimates, we found that the company’s earnings are expected to accelerate. For more on the company’s future earnings growth forecast, check out this free company analyst forecast report to learn more.

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About Ian Crawford

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