Magnolia Oil & Gas (NYSE:MGY) has had a rough month with its share price down 4.5%. 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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Is ROE Calculated?

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 March 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.23 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. 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 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 18% which is quite remarkable. As a result, Magnolia Oil & Gas' exceptional 50% net income growth seen over the past five years, doesn't come as a surprise.

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%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for MGY? You can find out in our latest intrinsic value infographic research report.

Is Magnolia Oil & Gas Making Efficient Use Of Its Profits?

Magnolia Oil & Gas has a really low three-year median payout ratio of 9.8%, meaning that it has the remaining 90% 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.

Additionally, Magnolia Oil & Gas has paid dividends over a period of three years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 24% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 18%, over the same period.

Summary

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. 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 latest analysts predictions for the company, check out this visualization of analyst forecasts 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.