Most readers would already be aware that MEG Energy's (TSE:MEG) stock increased significantly by 13% over the past month. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Specifically, we decided to study MEG Energy'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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for MEG 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 MEG Energy is:

13% = CA$586m ÷ CA$4.6b (Based on the trailing twelve months to June 2024).

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$0.13 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

MEG Energy's Earnings Growth And 13% ROE

To start with, MEG Energy's ROE looks acceptable. Especially when compared to the industry average of 9.7% the company's ROE looks pretty impressive. This probably laid the ground for MEG Energy's significant 56% 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.

We then compared MEG Energy's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 39% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is MEG fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is MEG Energy Efficiently Re-investing Its Profits?

MEG Energy's ' three-year median payout ratio is on the lower side at 4.7% implying that it is retaining a higher percentage (95%) 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.

Our latest analyst data shows that the future payout ratio of the company is expected to rise to 20% over the next three years.

Summary

On the whole, we feel that MEG Energy'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. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.