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Beach Energy Limited's (ASX:BPT) Stock Is Going Strong: Is the Market Following Fundamentals?

·4 min read

Most readers would already be aware that Beach Energy's (ASX:BPT) stock increased significantly by 19% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. In this article, we decided to focus on Beach Energy's ROE.

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 Beach Energy

How Do You 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 Beach Energy is:

22% = AU$573m ÷ AU$2.6b (Based on the trailing twelve months to December 2019).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.22 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learnt 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.

Beach Energy's Earnings Growth And 22% ROE

To begin with, Beach Energy seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 7.9%. This probably laid the ground for Beach Energy's significant 61% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Beach Energy'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 38%.

ASX:BPT Past Earnings Growth July 4th 2020
ASX:BPT Past Earnings Growth July 4th 2020

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for BPT? You can find out in our latest intrinsic value infographic research report.

Is Beach Energy Using Its Retained Earnings Effectively?

Beach Energy's ' three-year median payout ratio is on the lower side at 10% implying that it is retaining a higher percentage (90%) of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Additionally, Beach Energy has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 15% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company's expected ROE (to 13%) over the same period.

Summary

Overall, we are quite pleased with Beach Energy's performance. 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 substantial growth in its earnings. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.