Should Weakness in Epsilon Energy Ltd.'s (NASDAQ:EPSN) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

With its stock down 24% over the past month, it is easy to disregard Epsilon Energy (NASDAQ:EPSN). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Epsilon Energy's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

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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 Epsilon Energy is:

4.5% = US$4.4m ÷ US$100m (Based on the trailing twelve months to March 2025).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.04 in profit.

View our latest analysis for Epsilon Energy

What Has ROE Got To Do With 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. 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 Epsilon Energy's Earnings Growth And 4.5% ROE

It is hard to argue that Epsilon Energy's ROE is much good in and of itself. Even compared to the average industry ROE of 13%, the company's ROE is quite dismal. Epsilon Energy was still able to see a decent net income growth of 7.1% over the past five years. We reckon that there could be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared Epsilon Energy's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 37% in the same 5-year period, which is a bit concerning.

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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Epsilon Energy's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Epsilon Energy Making Efficient Use Of Its Profits?

Epsilon Energy has a three-year median payout ratio of 41%, which implies that it retains the remaining 59% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Besides, Epsilon Energy has been paying dividends over a period of three years. This shows that the company is committed to sharing profits with its shareholders.

Conclusion

On the whole, we do feel that Epsilon Energy has some positive attributes. That is, a decent growth in earnings backed by a high rate of reinvestment. However, we do feel that that earnings growth could have been higher if the business were to improve on the low ROE rate. Especially given how the company is reinvesting a huge chunk of its profits. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard would have the 2 risks we have identified for Epsilon Energy.

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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.