Most readers would already be aware that Warrior Met Coal's (NYSE:HCC) stock increased significantly by 33% over the past month. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to Warrior Met Coal's ROE today.
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.
How Do You Calculate Return On Equity?
Return on equity 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 Warrior Met Coal is:
48% = US$620m ÷ US$1.3b (Based on the trailing twelve months to June 2022).
The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.48 in profit.
Why Is ROE Important For 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.
Warrior Met Coal's Earnings Growth And 48% ROE
Firstly, we acknowledge that Warrior Met Coal has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 20% also doesn't go unnoticed by us. Needless to say, we are quite surprised to see that Warrior Met Coal's net income shrunk at a rate of 24% over the past five years. We reckon that there could be some other factors at play here that are preventing the company's growth. These include low earnings retention or poor allocation of capital.
However, when we compared Warrior Met Coal's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 28% in the same period. This is quite worrisome.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Warrior Met Coal's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Warrior Met Coal Making Efficient Use Of Its Profits?
Warrior Met Coal's low three-year median payout ratio of 1.8% (or a retention ratio of 98%) over the last three years should mean that the company is retaining most of its earnings to fuel its growth but the company's earnings have actually shrunk. This typically shouldn't be the case when a company is retaining most of its earnings. So there might be other factors at play here which could potentially be hampering growth. For instance, the business has faced some headwinds.
Additionally, Warrior Met Coal has paid dividends over a period of five years, which means that the company's management is rather focused on keeping up its dividend payments, regardless of the shrinking earnings. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 4.3% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 17% over the same period.
In total, it does look like Warrior Met Coal has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. Additionally, the latest industry analyst forecasts show that analysts expect the company's earnings to continue to shrink in the future. 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. 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.