Parex Resources Inc. (TSE:PXT) Stock Has Shown Weakness Lately But Financials Look Strong: Should Prospective Shareholders Make The Leap?

Parex Resources (TSE:PXT) has had a rough three months with its share price down 8.4%. 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. Specifically, we decided to study Parex Resources' ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Parex Resources

How Do You Calculate Return On Equity?

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 Parex Resources is:

29% = US$521m ÷ US$1.8b (Based on the trailing twelve months to June 2023).

The 'return' is the yearly profit. That means that for every CA$1 worth of shareholders' equity, the company generated CA$0.29 in profit.

Why Is ROE Important For 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 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.

Parex Resources' Earnings Growth And 29% ROE

Firstly, we acknowledge that Parex Resources has a significantly high ROE. Secondly, even when compared to the industry average of 20% the company's ROE is quite impressive. Probably as a result of this, Parex Resources was able to see a decent net income growth of 9.7% over the last five years.

As a next step, we compared Parex Resources' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 41% in the same period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 PXT? You can find out in our latest intrinsic value infographic research report.

Is Parex Resources Making Efficient Use Of Its Profits?

Parex Resources' three-year median payout ratio to shareholders is 13% (implying that it retains 87% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

While Parex Resources has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 23% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 21%, over the same period.

Conclusion

On the whole, we feel that Parex Resources' performance has been quite good. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see a good amount of growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. You can see the 3 risks we have identified for Parex Resources by visiting our risks dashboard for free on our platform here.

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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.