With its stock down 17% over the past three months, it is easy to disregard ChampionX (NASDAQ:CHX). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study ChampionX'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.

View our latest analysis for ChampionX

How Is ROE Calculated?

Return on equity 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 ChampionX is:

18% = US$307m ÷ US$1.7b (Based on the trailing twelve months to September 2023).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.18 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. 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 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.

ChampionX's Earnings Growth And 18% ROE

To start with, ChampionX's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 12%. Probably as a result of this, ChampionX was able to see an impressive net income growth of 29% over the last five years. We reckon that there could also be other factors at play here. Such as - high earnings retention or an efficient management in place.

We then compared ChampionX'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 23% 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 CHX fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is ChampionX Making Efficient Use Of Its Profits?

ChampionX's three-year median payout ratio is a pretty moderate 25%, meaning the company retains 75% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like ChampionX is reinvesting its earnings efficiently.

While ChampionX has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 18% over the next three years. As a result, the expected drop in ChampionX's payout ratio explains the anticipated rise in the company's future ROE to 22%, over the same period.

Conclusion

On the whole, we feel that ChampionX'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, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.