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Methanex (TSE:MX) has had a great run on the share market with its stock up by a significant 24% over the last month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Methanex's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
View our latest analysis for Methanex
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 Methanex is:
11% = US$255m ÷ US$2.3b (Based on the trailing twelve months to September 2024).
The 'return' is the yearly profit. That means that for every CA$1 worth of shareholders' equity, the company generated CA$0.11 in profit.
Why Is ROE Important For 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. 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 Methanex's Earnings Growth And 11% ROE
At first glance, Methanex seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 7.1%. Probably as a result of this, Methanex was able to see a decent growth of 19% over the last five years.
As a next step, we compared Methanex's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 18% in the same 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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Methanex's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Methanex Using Its Retained Earnings Effectively?
In Methanex's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 16% (or a retention ratio of 84%), which suggests that the company is investing most of its profits to grow its business.