It is hard to get excited after looking at New Zealand Oil & Gas' (NZSE:NZO) recent performance, when its stock has declined 18% over the past month. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on New Zealand Oil & Gas' ROE.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
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 New Zealand Oil & Gas is:
12% = NZ$15m ÷ NZ$122m (Based on the trailing twelve months to December 2021).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every NZ$1 of its shareholder's investments, the company generates a profit of NZ$0.12.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.
New Zealand Oil & Gas' Earnings Growth And 12% ROE
At first glance, New Zealand Oil & Gas seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 14%. However, while New Zealand Oil & Gas has a pretty respectable ROE, its five year net income decline rate was 17% . We reckon that there could be some other factors at play here that are preventing the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
However, when we compared New Zealand Oil & Gas' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 6.2% 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. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if New Zealand Oil & Gas is trading on a high P/E or a low P/E, relative to its industry.
Is New Zealand Oil & Gas Efficiently Re-investing Its Profits?
New Zealand Oil & Gas doesn't pay any dividend, meaning that the company is keeping all of its profits, which makes us wonder why it is retaining its earnings if it can't use them to grow its business. So there could be some other explanations in that regard. For instance, the company's business may be deteriorating.
Overall, we feel that New Zealand Oil & Gas certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. 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. To know the 4 risks we have identified for New Zealand Oil & Gas visit our risks dashboard for free.
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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.