With its stock down 19% over the past three months, it is easy to disregard Civitas Resources (NYSE:CIVI). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Civitas Resources' ROE.

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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Civitas Resources

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 Civitas Resources is:

15% = US$765m ÷ US$5.0b (Based on the trailing twelve months to June 2022).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.15 in profit.

What Has ROE Got To Do With 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.

A Side By Side comparison of Civitas Resources' Earnings Growth And 15% ROE

At first glance, Civitas Resources seems to have a decent ROE. Be that as it may, the company's ROE is still quite lower than the industry average of 26%. However, we are pleased to see the impressive 47% net income growth reported by Civitas Resources over the past five years. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this certainly also provides some context to the high earnings growth seen by the company.

Given that the industry shrunk its earnings at a rate of 3.4% in the same period, the net income growth of the company is quite impressive.

Earnings growth is an important metric to consider when valuing a stock. 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. If you're wondering about Civitas Resources''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.