Northern Star Resources' (ASX:NST) stock is up by a considerable 15% over the past month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Northern Star Resources' ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Is ROE Calculated?
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 Northern Star Resources is:
12% = AU$258m ÷ AU$2.1b (Based on the trailing twelve months to June 2020).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.12 in profit.
What Has ROE Got To Do With 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 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.
A Side By Side comparison of Northern Star Resources' Earnings Growth And 12% ROE
To start with, Northern Star Resources' ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 13%. Consequently, this likely laid the ground for the decent growth of 9.2% seen over the past five years by Northern Star Resources.
We then compared Northern Star Resources' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 32% in the same period, which is a bit concerning.
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. Doing so will help them establish if the stock's future looks promising or ominous. Is NST fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Northern Star Resources Efficiently Re-investing Its Profits?
With a three-year median payout ratio of 44% (implying that the company retains 56% of its profits), it seems that Northern Star Resources is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.
Moreover, Northern Star Resources is determined to keep sharing its profits with shareholders which we infer from its long history of eight years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 22% over the next three years. The fact that the company's ROE is expected to rise to 22% over the same period is explained by the drop in the payout ratio.
On the whole, we feel that Northern Star Resources' performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a respectable growth in its earnings. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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This article by Simply Wall St is general in nature. 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.
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