With its stock down 23% over the past three months, it is easy to disregard Central Petroleum (ASX:CTP). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Central Petroleum's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Central Petroleum

How Do You Calculate Return On Equity?

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 Central Petroleum is:

51% = AU$17m ÷ AU$34m (Based on the trailing twelve months to December 2023).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.51.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

Central Petroleum's Earnings Growth And 51% ROE

To begin with, Central Petroleum has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 15% which is quite remarkable. Under the circumstances, Central Petroleum's considerable five year net income growth of 28% was to be expected.

We then performed a comparison between Central Petroleum's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 33% in the same 5-year period.

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