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SM Energy (NYSE:SM) has had a rough month with its share price down 6.5%. 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 SM Energy's ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out our latest analysis for SM Energy
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 SM Energy is:
20% = US$829m ÷ US$4.1b (Based on the trailing twelve months to September 2024).
The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.20.
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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
SM Energy's Earnings Growth And 20% ROE
At first glance, SM Energy seems to have a decent ROE. On comparing with the average industry ROE of 15% the company's ROE looks pretty remarkable. This certainly adds some context to SM Energy's exceptional 52% net income growth seen over the past 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.
As a next step, we compared SM Energy's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 41%.
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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is SM Energy fairly valued compared to other companies? These 3 valuation measures might help you decide.