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Whitehaven Coal Limited's (ASX:WHC) Stock Is Going Strong: Have Financials A Role To Play?

·4 min read

Whitehaven Coal (ASX:WHC) has had a great run on the share market with its stock up by a significant 47% over the last three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on Whitehaven Coal's ROE.

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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Whitehaven Coal

How To 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 Whitehaven Coal is:

46% = AU$2.0b ÷ AU$4.2b (Based on the trailing twelve months to June 2022).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.46 in profit.

What Is The Relationship Between ROE And Earnings Growth?

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

Whitehaven Coal's Earnings Growth And 46% ROE

To begin with, Whitehaven Coal has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 24% which is quite remarkable. As you might expect, the 8.5% net income decline reported by Whitehaven Coal doesn't bode well with us. So, there might be some other aspects that could explain this. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

That being said, we compared Whitehaven Coal's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 11% in the same period.

past-earnings-growth
past-earnings-growth

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. Doing so will help them establish if the stock's future looks promising or ominous. What is WHC worth today? The intrinsic value infographic in our free research report helps visualize whether WHC is currently mispriced by the market.

Is Whitehaven Coal Using Its Retained Earnings Effectively?

In spite of a normal three-year median payout ratio of 27% (that is, a retention ratio of 73%), the fact that Whitehaven Coal's earnings have shrunk is quite puzzling. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, Whitehaven Coal has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 44% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 13% over the same period.

Summary

In total, it does look like Whitehaven Coal has some positive aspects to its business. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its growth. In addition, on studying the latest analyst forecasts, we found that the company's earnings are expected to continue to shrink. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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

This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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