Are MGE Energy, Inc.'s (NASDAQ:MGEE) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

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Simply Wall St

Sat, Sep 23, 2023, 7:51 AM 4 min read

It is hard to get excited after looking at MGE Energy's (NASDAQ:MGEE) recent performance, when its stock has declined 3.2% over the past three months. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on MGE Energy's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for MGE Energy

How Do You Calculate Return On Equity?

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 MGE Energy is:

10% = US$115m ÷ US$1.1b (Based on the trailing twelve months to June 2023).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.10 in profit.

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. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

MGE Energy's Earnings Growth And 10% ROE

To start with, MGE Energy's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 8.3%. Despite this, MGE Energy's five year net income growth was quite low averaging at only 4.5%. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn't been able to do so. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or poor allocation of capital.

As a next step, we compared MGE Energy's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 6.8% in the same period.

past-earnings-growth — NasdaqGS:MGEE Past Earnings Growth September 23rd 2023

Earnings growth is an important metric to consider when valuing a stock. 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. If you're wondering about MGE Energy's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is MGE Energy Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 53% (or a retention ratio of 47%), most of MGE Energy's profits are being paid to shareholders. This definitely contributes to the low earnings growth seen by the company.

Additionally, MGE 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 47%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 12%.

Summary

In total, it does look like MGE Energy has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.