3D Oil's (ASX:TDO) stock is up by 9.8% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to 3D Oil's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
See our latest analysis for 3D Oil
How Is ROE Calculated?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for 3D Oil is:
34% = AU$3.4m ÷ AU$9.9m (Based on the trailing twelve months to June 2023).
The 'return' is the yearly profit. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.34 in profit.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
3D Oil's Earnings Growth And 34% ROE
Firstly, we acknowledge that 3D Oil has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 24% which is quite remarkable. Under the circumstances, 3D Oil's considerable five year net income growth of 26% was to be expected.
We then compared 3D Oil's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 38% in the same 5-year period, which is a bit concerning.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if 3D Oil is trading on a high P/E or a low P/E, relative to its industry.