It is hard to get excited after looking at Matador Resources' (NYSE:MTDR) recent performance, when its stock has declined 5.3% over the past month. However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Matador Resources' ROE today.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How To 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 Matador Resources is:

20% = US$1.0b ÷ US$5.1b (Based on the trailing twelve months to September 2024).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.20 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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company's earnings growth potential. 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.

A Side By Side comparison of Matador Resources' Earnings Growth And 20% ROE

To start with, Matador Resources' ROE looks acceptable. On comparing with the average industry ROE of 15% the company's ROE looks pretty remarkable. Probably as a result of this, Matador Resources was able to see an impressive net income growth of 43% over the last five years. However, there could also be other causes behind this growth. Such as - high earnings retention or an efficient management in place.

We then performed a comparison between Matador Resources' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 40% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. 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 Matador Resources is trading on a high P/E or a low P/E, relative to its industry.

Is Matador Resources Using Its Retained Earnings Effectively?

Matador Resources' ' three-year median payout ratio is on the lower side at 4.0% implying that it is retaining a higher percentage (96%) of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Additionally, Matador Resources has paid dividends over a period of four years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 12% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 16% over the same period.

Conclusion

Overall, we are quite pleased with Matador Resources' performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.