Most readers would already be aware that Cabot's (NYSE:CBT) stock increased significantly by 27% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Cabot's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. 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 Cabot is:

32% = US$479m ÷ US$1.5b (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.32 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

A Side By Side comparison of Cabot's Earnings Growth And 32% ROE

To begin with, Cabot has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 13% the company's ROE is quite impressive. Under the circumstances, Cabot's considerable five year net income growth of 28% was to be expected.

We then compared Cabot's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 14% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. 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 Making Efficient Use Of Its Profits?

Cabot's three-year median payout ratio is a pretty moderate 26%, meaning the company retains 74% of its income. So it seems that Cabot is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Besides, Cabot has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its 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 23%. Accordingly, forecasts suggest that Cabot's future ROE will be 26% which is again, similar to the current ROE.

Conclusion

On the whole, we feel that Cabot's performance has been quite good. 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. 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. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. 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.