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Most readers would already know that Horizon Oil's (ASX:HZN) stock increased by 3.2% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to investigate if the company's decent financials had a hand to play in the recent price move. Particularly, we will be paying attention to Horizon Oil's ROE today.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company's success at turning shareholder investments into profits.
See our latest analysis for Horizon Oil
How Do You Calculate Return On Equity?
Return on equity 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 Horizon Oil is:
41% = US$35m ÷ US$86m (Based on the trailing twelve months to December 2022).
The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.41 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.
Horizon Oil's Earnings Growth And 41% ROE
Firstly, we acknowledge that Horizon Oil has a significantly high ROE. Secondly, even when compared to the industry average of 20% the company's ROE is quite impressive. This likely paved the way for the modest 17% net income growth seen by Horizon Oil over the past five years. growth
We then compared Horizon Oil's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 23% in the same period, which is a bit concerning.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Horizon Oil fairly valued compared to other companies? These 3 valuation measures might help you decide.