Spark Energy's (NASDAQ:SPKE) stock up by 4.0% over the past week. As most would know, long-term fundamentals have a strong correlation with market price movements, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Spark 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Spark Energy

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Spark Energy is:

33% = US$59m ÷ US$177m (Based on the trailing twelve months to September 2020).

The 'return' is the amount earned after tax over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.33 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively 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 profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Spark Energy's Earnings Growth And 33% ROE

To begin with, Spark Energy has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 9.4% the company's ROE is quite impressive. As you might expect, the 3.5% net income decline reported by Spark Energy doesn't bode well with us. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. These include low earnings retention or poor allocation of capital.

However, when we compared Spark Energy's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 7.3% in the same period. This is quite worrisome.

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). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Spark Energy's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Spark Energy Making Efficient Use Of Its Profits?

Spark Energy's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 84% (or a retention ratio of 16%). With only very little left to reinvest into the business, growth in earnings is far from likely. To know the 4 risks we have identified for Spark Energy visit our risks dashboard for free.

Moreover, Spark Energy has been paying dividends for six years, which is a considerable amount of time, suggesting that management must have perceived that the shareholders prefer consistent dividends even though earnings have been shrinking.

Conclusion

Overall, we feel that Spark Energy certainly does have some positive factors to consider. 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. Up till now, we've only made a short study of the company's growth data. To gain further insights into Spark Energy's past profit growth, check out this visualization of past earnings, revenue and cash flows.

This article by Simply Wall St is general in nature. 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.

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