Is Weakness In Headwater Exploration Inc. (TSE:HWX) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

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editorial-team@simplywallst.com (Simply Wall St)

Fri, Oct 25, 2024, 4:15 AM 3 min read

Headwater Exploration (TSE:HWX) has had a rough three months with its share price down 8.1%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Headwater Exploration's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Headwater Exploration

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 Headwater Exploration is:

28% = CA$187m ÷ CA$658m (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every CA$1 worth of equity, the company was able to earn CA$0.28 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

A Side By Side comparison of Headwater Exploration's Earnings Growth And 28% ROE

First thing first, we like that Headwater Exploration has an impressive ROE. Secondly, even when compared to the industry average of 9.7% the company's ROE is quite impressive. So, the substantial 57% net income growth seen by Headwater Exploration over the past five years isn't overly surprising.

Next, on comparing with the industry net income growth, we found that Headwater Exploration's growth is quite high when compared to the industry average growth of 38% in the same period, which is great to see.

past-earnings-growth — TSX:HWX Past Earnings Growth October 25th 2024

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is Headwater Exploration fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Headwater Exploration Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 53% (implying that it keeps only 47% of profits) for Headwater Exploration suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.

While Headwater Exploration 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 48%.

Conclusion

In total, we are pretty happy with Headwater Exploration's performance. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. 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.