BHP Group Limited's (ASX:BHP) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

With its stock down 6.7% over the past three months, it is easy to disregard BHP Group (ASX:BHP). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study BHP Group'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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for BHP Group

How Do You Calculate Return On Equity?

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 BHP Group is:

20% = US$9.6b ÷ US$49b (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.20.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 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 BHP Group's Earnings Growth And 20% ROE

To begin with, BHP Group seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 11%. Probably as a result of this, BHP Group was able to see a decent growth of 6.2% over the last five years.

We then compared BHP Group's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 21% in the same 5-year period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for BHP? You can find out in our latest intrinsic value infographic research report.

Is BHP Group Making Efficient Use Of Its Profits?

While BHP Group has a three-year median payout ratio of 94% (which means it retains 6.3% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.

Additionally, BHP Group 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 55% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.

Conclusion

In total, it does look like BHP Group has some positive aspects to its business. Its earnings have grown respectably as we saw earlier, probably due to its high returns. However, it does reinvest little to almost none of its profits, so we wonder what effect this could have on its future growth prospects. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. 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.