It is hard to get excited after looking at Magnolia Oil & Gas' (NYSE:MGY) recent performance, when its stock has declined 16% over the past week. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Magnolia Oil & Gas' ROE.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

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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' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.20 in profit.

See our latest analysis for Magnolia Oil & Gas

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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Magnolia Oil & Gas' Earnings Growth And 20% ROE

At first glance, Magnolia Oil & Gas seems to have a decent ROE. Especially when compared to the industry average of 14% the company's ROE looks pretty impressive. This certainly adds some context to Magnolia Oil & Gas' exceptional 50% net income growth seen over the past five years. We reckon that there could also be other factors at play here. 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.

As a next step, we compared Magnolia Oil & Gas' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 38%.

Earnings growth is an important metric to consider when valuing a stock. 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. If you're wondering about Magnolia Oil & Gas''s valuation, check out this gauge of its price-to-earnings ratio , as compared to its industry.

Is Magnolia Oil & Gas Using Its Retained Earnings Effectively?

Magnolia Oil & Gas' ' three-year median payout ratio is on the lower side at 13% implying that it is retaining a higher percentage (87%) of its profits. So it looks like Magnolia Oil & Gas is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Besides, Magnolia Oil & Gas has been paying dividends over a period of four years. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 32% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.

Conclusion

On the whole, we feel that Magnolia Oil & Gas' 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. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.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.