Most readers would already be aware that East West Petroleum's (CVE:EW) stock increased significantly by 33% over the past month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study East West Petroleum's ROE in this article.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Is ROE Calculated?
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 East West Petroleum is:
21% = CA$1.3m ÷ CA$6.1m (Based on the trailing twelve months to September 2020).
The 'return' is the yearly profit. Another way to think of that is that for every CA$1 worth of equity, the company was able to earn CA$0.21 in profit.
What Is The Relationship Between ROE And Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.
East West Petroleum's Earnings Growth And 21% ROE
At first glance, East West Petroleum seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 8.1%. This probably laid the ground for East West Petroleum's significant 39% 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. For instance, the company has a low payout ratio or is being managed efficiently.
Next, on comparing East West Petroleum's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 39% in the same period.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is East West Petroleum fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is East West Petroleum Efficiently Re-investing Its Profits?
On the whole, we feel that East West Petroleum's performance has been quite good. 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. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. To know the 3 risks we have identified for East West Petroleum visit our risks dashboard for free.
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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