Headwater Exploration Inc.'s (TSE:HWX) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

Headwater Exploration (TSE:HWX) has had a rough three months with its share price down 24%. 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 a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

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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 Headwater Exploration is:

27% = CA$188m ÷ CA$699m (Based on the trailing twelve months to December 2024).

The 'return' is the income the business earned 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$0.27 in profit.

View our latest analysis for Headwater Exploration

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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of Headwater Exploration's Earnings Growth And 27% ROE

First thing first, we like that Headwater Exploration has an impressive ROE. Secondly, even when compared to the industry average of 11% the company's ROE is quite impressive. Under the circumstances, Headwater Exploration's considerable five year net income growth of 50% was to be expected.

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 37% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Headwater Exploration's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Headwater Exploration Using Its Retained Earnings Effectively?

Headwater Exploration has a significant three-year median payout ratio of 51%, meaning the company only retains 49% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.

Along with seeing a growth in earnings, Headwater Exploration only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 94% over the next three years.

Summary

Overall, we are quite pleased with Headwater Exploration's performance. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. 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. 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.