Ovintiv (NYSE:OVV) has had a rough month with its share price down 15%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Ovintiv's ROE today.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Ovintiv

How To Calculate Return On Equity?

The formula for ROE is:

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

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

19% = US$2.0b ÷ US$11b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.19 in profit.

What Is The Relationship Between ROE And 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.

Ovintiv's Earnings Growth And 19% ROE

To begin with, Ovintiv seems to have a respectable ROE. On comparing with the average industry ROE of 15% the company's ROE looks pretty remarkable. This probably laid the ground for Ovintiv's significant 45% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

Next, on comparing Ovintiv's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 40% over the last few years.

Earnings growth is a huge factor in stock valuation. 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 Ovintiv is trading on a high P/E or a low P/E, relative to its industry.

Is Ovintiv Efficiently Re-investing Its Profits?

Ovintiv's three-year median payout ratio to shareholders is 8.6%, which is quite low. This implies that the company is retaining 91% of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

Moreover, Ovintiv is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 20% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 12% over the same period.

Conclusion

In total, we are pretty happy with Ovintiv's 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, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. 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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