Telefónica Deutschland Holding AG (ETR:O2D) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?

editorial-team@simplywallst.com (Simply Wall St)

Wed, Nov 29, 2023, 12:02 AM 4 min read

Telefónica Deutschland Holding (ETR:O2D) has had a great run on the share market with its stock up by a significant 49% over the last month. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on Telefónica Deutschland Holding'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.

Check out our latest analysis for Telefónica Deutschland Holding

How Is ROE Calculated?

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 Telefónica Deutschland Holding is:

4.7% = €251m ÷ €5.4b (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. Another way to think of that is that for every €1 worth of equity, the company was able to earn €0.05 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of Telefónica Deutschland Holding's Earnings Growth And 4.7% ROE

At first glance, Telefónica Deutschland Holding's ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 7.2% either. However, we we're pleasantly surprised to see that Telefónica Deutschland Holding grew its net income at a significant rate of 53% in the last five years. So, there might be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Telefónica Deutschland Holding's growth is quite high when compared to the industry average growth of 15% in the same period, which is great to see.

past-earnings-growth — XTRA:O2D Past Earnings Growth November 29th 2023

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Telefónica Deutschland Holding's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Telefónica Deutschland Holding Efficiently Re-investing Its Profits?

Telefónica Deutschland Holding's very high three-year median payout ratio of 174% suggests that the company is paying more to its shareholders than what it is earning. In spite of this, the company was able to grow its earnings significantly, as we saw above. Having said that, the high payout ratio is definitely risky and something to keep an eye on. Our risks dashboard should have the 4 risks we have identified for Telefónica Deutschland Holding.

Besides, Telefónica Deutschland Holding has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. 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 205%. As a result, Telefónica Deutschland Holding's ROE is not expected to change by much either, which we inferred from the analyst estimate of 3.9% for future ROE.

Summary

On the whole, we feel that the performance shown by Telefónica Deutschland Holding can be open to many interpretations. Although the company has shown a pretty impressive growth in earnings, yet the low ROE and the low rate of reinvestment makes us skeptical about the continuity of that growth, especially when or if the business comes to face any threats. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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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.