Meritage Homes' (NYSE:MTH) stock is up by a considerable 12% over the past three months. Since the market usually pay for a company's long-term fundamentals, we decided to study the company's key performance indicators to see if they could be influencing the market. Particularly, we will be paying attention to Meritage Homes' 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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How Do You 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 Meritage Homes is:

17% = US$838m ÷ US$4.9b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.17.

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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

A Side By Side comparison of Meritage Homes' Earnings Growth And 17% ROE

At first glance, Meritage Homes seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 15%. This probably goes some way in explaining Meritage Homes' significant 24% net income growth over the past five years amongst other factors. We reckon that there could also be other factors at play here. Such as - high earnings retention or an efficient management in place.

As a next step, we compared Meritage Homes' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 22% in the same period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. 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 Meritage Homes is trading on a high P/E or a low P/E, relative to its industry.

Is Meritage Homes Efficiently Re-investing Its Profits?

Meritage Homes' three-year median payout ratio to shareholders is 4.5%, which is quite low. This implies that the company is retaining 95% of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

While Meritage Homes has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 17% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company's expected ROE (to 14%) over the same period.

Conclusion

In total, we are pretty happy with Meritage Homes' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings 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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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.