Most readers would already know that Magnolia Oil & Gas' (NYSE:MGY) stock increased by 3.0% over the past week. Given its impressive performance, we decided to study the company's key financial indicators as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Magnolia Oil & Gas' 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 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 Magnolia Oil & Gas is:

23% = US$434m ÷ US$1.9b (Based on the trailing twelve months to June 2024).

The 'return' is the profit 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 $0.23 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 Magnolia Oil & Gas' Earnings Growth And 23% ROE

To begin with, Magnolia Oil & Gas has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 16% which is quite remarkable. So, the substantial 51% net income growth seen by Magnolia Oil & Gas over the past five years isn't overly surprising.

We then compared Magnolia Oil & Gas' 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 40% in the same 5-year period.

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. 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 Magnolia Oil & Gas is trading on a high P/E or a low P/E, relative to its industry.

Is Magnolia Oil & Gas Efficiently Re-investing Its Profits?

Magnolia Oil & Gas' ' three-year median payout ratio is on the lower side at 10.0% implying that it is retaining a higher percentage (90%) 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.

Besides, Magnolia Oil & Gas has been paying dividends over a period of three years. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 24% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 15% over the same period.

Summary

In total, we are pretty happy with Magnolia Oil & Gas' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. 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. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.