Whitehaven Coal Limited's (ASX:WHC) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

It is hard to get excited after looking at Whitehaven Coal's (ASX:WHC) recent performance, when its stock has declined 20% over the past three months. 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. Particularly, we will be paying attention to Whitehaven Coal's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Whitehaven Coal

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Whitehaven Coal is:

67% = AU$3.4b ÷ AU$5.0b (Based on the trailing twelve months to December 2022).

The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.67 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

Whitehaven Coal's Earnings Growth And 67% ROE

First thing first, we like that Whitehaven Coal has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 21% also doesn't go unnoticed by us. As a result, Whitehaven Coal's exceptional 34% net income growth seen over the past five years, doesn't come as a surprise.

We then compared Whitehaven Coal'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 period.

Earnings growth is a huge factor in stock valuation. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Whitehaven Coal is trading on a high P/E or a low P/E, relative to its industry.

Is Whitehaven Coal Making Efficient Use Of Its Profits?

Whitehaven Coal's three-year median payout ratio to shareholders is 21%, which is quite low. This implies that the company is retaining 79% of its profits. So it looks like Whitehaven Coal is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Additionally, Whitehaven Coal has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 37% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company's expected ROE (to 17%) over the same period.

Summary

In total, we are pretty happy with Whitehaven Coal's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. 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.