It is hard to get excited after looking at Magnolia Oil & Gas' (NYSE:MGY) recent performance, when its stock has declined 23% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Magnolia Oil & Gas' 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

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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 Magnolia Oil & Gas is:

20% = US$397m ÷ US$2.0b (Based on the trailing twelve months to December 2024).

The 'return' refers to a company's earnings over the last year. That means that for every $1 worth of shareholders' equity, the company generated $0.20 in profit.

View our latest analysis for Magnolia Oil & Gas

Why Is ROE Important For 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 Magnolia Oil & Gas' Earnings Growth And 20% ROE

At first glance, Magnolia Oil & Gas seems to have a decent ROE. On comparing with the average industry ROE of 14% the company's ROE looks pretty remarkable. This probably laid the ground for Magnolia Oil & Gas' significant 50% net income growth seen over the past five years. However, there could also be other causes behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

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 38% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. 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 Using Its Retained Earnings Effectively?

Magnolia Oil & Gas has a really low three-year median payout ratio of 13%, meaning that it has the remaining 87% left over to reinvest into its business. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Moreover, Magnolia Oil & Gas is determined to keep sharing its profits with shareholders which we infer from its long history of four years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 29% over the next three years. However, the company's ROE is not expected to change by much despite the higher expected payout ratio.

Conclusion

Overall, we are quite pleased 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. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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.