It is hard to get excited after looking at California Water Service Group's (NYSE:CWT) recent performance, when its stock has declined 9.4% over the past month. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. Specifically, we decided to study California Water Service Group's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. 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?

Return on equity 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 California Water Service Group is:

9.7% = US$143m ÷ US$1.5b (Based on the trailing twelve months to March 2024).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.10 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

California Water Service Group's Earnings Growth And 9.7% ROE

On the face of it, California Water Service Group's ROE is not much to talk about. Yet, a closer study shows that the company's ROE is similar to the industry average of 9.6%. On the other hand, California Water Service Group reported a moderate 5.2% net income growth over the past five years. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's 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.

We then compared California Water Service Group's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 11% in the same 5-year period, which is a bit concerning.

Earnings growth is an important metric to consider when valuing a stock. 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 California Water Service Group is trading on a high P/E or a low P/E, relative to its industry.

Is California Water Service Group Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 57% (or a retention ratio of 43%) for California Water Service Group suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Additionally, California Water Service Group has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 50%. Accordingly, forecasts suggest that California Water Service Group's future ROE will be 9.0% which is again, similar to the current ROE.

Summary

Overall, we have mixed feelings about California Water Service Group. While the company has posted a decent earnings growth, We do feel that the earnings growth number could have been even higher, had the company been reinvesting more of its earnings at a higher rate of return. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.

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