Quanta Services (NYSE:PWR) has had a great run on the share market with its stock up by a significant 17% over the last three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Quanta Services' ROE in this article.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Quanta Services

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 Quanta Services is:

12% = US$711m ÷ US$6.0b (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.12 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don't share these attributes.

A Side By Side comparison of Quanta Services' Earnings Growth And 12% ROE

To begin with, Quanta Services seems to have a respectable ROE. Even when compared to the industry average of 11% the company's ROE looks quite decent. This certainly adds some context to Quanta Services' moderate 12% net income growth seen over the past five years.

As a next step, we compared Quanta Services' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 20% in the same period.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is PWR fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Quanta Services Efficiently Re-investing Its Profits?

In Quanta Services' case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 7.2% (or a retention ratio of 93%), which suggests that the company is investing most of its profits to grow its business.

Besides, Quanta Services has been paying dividends over a period of five years. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 4.0% over the next three years. Despite the lower expected payout ratio, the company's ROE is not expected to change by much.

Conclusion

On the whole, we feel that Quanta Services' performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see a good amount of growth in its earnings. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.