Evolution Petroleum (NYSEMKT:EPM) has had a rough three months with its share price down 25%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Evolution Petroleum's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
View our latest analysis for Evolution Petroleum
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 Evolution Petroleum is:
8.0% = US$5.9m ÷ US$74m (Based on the trailing twelve months to June 2020).
The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.08 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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. 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.
Evolution Petroleum's Earnings Growth And 8.0% ROE
At first glance, Evolution Petroleum's ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 14%. As a result, Evolution Petroleum reported a very low income growth of 2.8% over the past five years.
As a next step, we compared Evolution Petroleum's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 0.07%.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Evolution Petroleum's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Evolution Petroleum Efficiently Re-investing Its Profits?
Evolution Petroleum has a three-year median payout ratio of 86% (implying that it keeps only 14% of its profits), meaning that it pays out most of its profits to shareholders as dividends, and as a result, the company has seen low earnings growth.
In addition, Evolution Petroleum has been paying dividends over a period of seven years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.
Conclusion
In total, it does look like Evolution Petroleum has some positive aspects to its business. That is, quite an impressive growth in earnings. However, the low profit retention means that the company's earnings growth could have been higher, had it been reinvesting a higher portion of its profits. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard would have the 4 risks we have identified for Evolution Petroleum.
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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