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It is hard to get excited after looking at BHP Group's (ASX:BHP) recent performance, when its stock has declined 5.7% over the past three months. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to BHP Group's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.
See our latest analysis for BHP Group
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
So, based on the above formula, the ROE for BHP Group is:
20% = US$8.9b ÷ US$46b (Based on the trailing twelve months to December 2023).
The 'return' refers to a company's earnings over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.20.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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 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.
BHP Group's Earnings Growth And 20% ROE
To start with, BHP Group's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 10%. Probably as a result of this, BHP Group was able to see a decent growth of 13% over the last five years.
We then compared BHP Group's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 21% in the same 5-year period, which is a bit concerning.
Earnings growth is a huge factor in stock valuation. 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. What is BHP worth today? The intrinsic value infographic in our free research report helps visualize whether BHP is currently mispriced by the market.
Is BHP Group Efficiently Re-investing Its Profits?
The high three-year median payout ratio of 94% (or a retention ratio of 5.6%) for BHP Group suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.