Most readers would already be aware that Cabot's (NYSE:CBT) stock increased significantly by 14% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Cabot's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

How Do You Calculate Return On Equity?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Cabot is:

35% = US$524m ÷ US$1.5b (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.35 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. 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. 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.

A Side By Side comparison of Cabot's Earnings Growth And 35% ROE

First thing first, we like that Cabot has an impressive ROE. Additionally, the company's ROE is higher compared to the industry average of 9.6% which is quite remarkable. So, the substantial 39% net income growth seen by Cabot over the past five years isn't overly surprising.

Next, on comparing with the industry net income growth, we found that Cabot's growth is quite high when compared to the industry average growth of 12% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 Cabot's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Cabot Using Its Retained Earnings Effectively?

The three-year median payout ratio for Cabot is 26%, which is moderately low. The company is retaining the remaining 74%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Cabot is reinvesting its earnings efficiently.

Additionally, Cabot 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 22%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 29%.

Summary

On the whole, we feel that Cabot's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. You can see the 2 risks we have identified for Cabot by visiting our risks dashboard for free on our platform here.

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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.