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Horizon Oil Limited (ASX:HZN) Stock Has Shown Weakness Lately But Financials Look Strong: Should Prospective Shareholders Make The Leap?

It is hard to get excited after looking at Horizon Oil's (ASX:HZN) recent performance, when its stock has declined 7.1% over the past three months. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Horizon Oil's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Horizon Oil

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

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So, based on the above formula, the ROE for Horizon Oil is:

25% = US$24m ÷ US$99m (Based on the trailing twelve months to June 2022).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.25 in profit.

What Is The Relationship Between ROE And Earnings Growth?

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

Horizon Oil's Earnings Growth And 25% ROE

First thing first, we like that Horizon Oil has an impressive ROE. Further, even comparing with the industry average if 21%, the company's ROE is quite respectable. The high ROE therefore is what most likely laid the ground for the decent growth of 20% seen over the past five years by Horizon Oil.

As a next step, we compared Horizon Oil'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 12%.

past-earnings-growth
past-earnings-growth

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. Doing so will help them establish if the stock's future looks promising or ominous. Is Horizon Oil fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Horizon Oil Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 74% (or a retention ratio of 26%) for Horizon Oil suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Conclusion

Overall, we are quite pleased with Horizon Oil's performance. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. To gain further insights into Horizon Oil's past profit growth, check out this visualization of past earnings, revenue and cash flows.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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