SM Energy’s (NYSE:SM) stock is up by a considerable 40% 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. Specifically, we decided to study SM Energy’s ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for SM Energy

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 SM Energy is:

33% = US$1.1b ÷ US$3.3b (Based on the trailing twelve months to June 2023).

The ‘return’ is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each $1 of shareholders’ capital it has, the company made $0.33 in profit.

Why Is ROE Important For 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don’t have the same features.

SM Energy’s Earnings Growth And 33% ROE

To begin with, SM Energy has a pretty high ROE which is interesting. Additionally, a comparison with the average industry ROE of 28% also portrays the company’s ROE in a good light. Therefore, it might not be wrong to say that the impressive five year 35% net income growth seen by SM Energy was probably achieved as a result of the high ROE.

We then compared SM 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 28% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company’s expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. What is SM worth today? The intrinsic value infographic in our free research report helps visualize whether SM is currently mispriced by the market.

Is SM Energy Using Its Retained Earnings Effectively?

SM Energy’s ‘ three-year median payout ratio is on the lower side at 0.3% implying that it is retaining a higher percentage (100%) of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

Moreover, SM Energy is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Looking at the current analyst consensus data, we can see that the company’s future payout ratio is expected to rise to 8.9% over the next three years. Therefore, the expected rise in the payout ratio explains why the company’s ROE is expected to decline to 19% over the same period.

Conclusion

In total, we are pretty happy with SM Energy’s performance. In particular, it’s great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable 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. 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.

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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.