Is SM Energy Company's (NYSE:SM) Stock's Recent Performance Being Led By Its Attractive Financial Prospects?

SM Energy (NYSE:SM) has had a great run on the share market with its stock up by a significant 29% over the last three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to SM 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for SM Energy

How To Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for SM Energy is:

20% = US$751m ÷ US$3.7b (Based on the trailing twelve months to March 2024).

The 'return' is the income the business earned over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.20 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

SM Energy's Earnings Growth And 20% ROE

To start with, SM Energy's ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 18%. This certainly adds some context to SM Energy's exceptional 51% net income growth seen over the past five years. However, there could also be other drivers behind this growth. Such as - high earnings retention or an efficient management in place.

As a next step, we compared SM Energy's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 38%.

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 SM Energy's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is SM Energy Using Its Retained Earnings Effectively?

SM Energy's ' three-year median payout ratio is on the lower side at 3.4% implying that it is retaining a higher percentage (97%) of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

Additionally, SM Energy 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.

Summary

On the whole, we feel that SM Energy's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.