With its stock down 16% over the past three months, it is easy to disregard Shenandoah Telecommunications (NASDAQ:SHEN). We decided to study the company's financials to determine if the downtrend will continue as the long-term performance of a company usually dictates market outcomes. In this article, we decided to focus on Shenandoah Telecommunications' ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Shenandoah Telecommunications is:

1.2% = US$8.0m ÷ US$653m (Based on the trailing twelve months to December 2023).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.01 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.

Shenandoah Telecommunications' Earnings Growth And 1.2% ROE

It is hard to argue that Shenandoah Telecommunications' ROE is much good in and of itself. Even compared to the average industry ROE of 8.2%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 48% seen by Shenandoah Telecommunications was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. Such as - low earnings retention or poor allocation of capital.

That being said, we compared Shenandoah Telecommunications' performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 3.5% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is Shenandoah Telecommunications fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Shenandoah Telecommunications Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 56% (implying that 44% of the profits are retained), most of Shenandoah Telecommunications' profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent.

Additionally, Shenandoah Telecommunications 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 29% over the next three years.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Shenandoah Telecommunications. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. Moreover, after studying current analyst estimates, we discovered that the company's earnings are expected to continue to shrink in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.