Most readers would already be aware that Warrior Met Coal's (NYSE:HCC) stock increased significantly by 15% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study Warrior Met Coal's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

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 Warrior Met Coal is:

22% = US$433m ÷ US$2.0b (Based on the trailing twelve months to March 2024).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.22 in profit.

Why Is ROE Important For 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 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.

Warrior Met Coal's Earnings Growth And 22% ROE

To begin with, Warrior Met Coal seems to have a respectable ROE. Especially when compared to the industry average of 10% the company's ROE looks pretty impressive. This probably laid the ground for Warrior Met Coal's moderate 10% net income growth seen over the past five years.

As a next step, we compared Warrior Met Coal's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 25% in the same period.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is HCC fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Warrior Met Coal Using Its Retained Earnings Effectively?

Warrior Met Coal's three-year median payout ratio to shareholders is 1.9% (implying that it retains 98% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Additionally, Warrior Met Coal has paid dividends over a period of seven years which means that the company is pretty serious about sharing its profits with shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 4.5% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 15%, over the same period.

Summary

On the whole, we feel that Warrior Met Coal'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. As a result, the decent growth in its earnings is not surprising. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. 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.