It is hard to get excited after looking at Ovintiv's (NYSE:OVV) recent performance, when its stock has declined 13% over the past three months. 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 Ovintiv'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How To 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 Ovintiv is:

19% = US$1.9b ÷ US$10b (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 $0.19.

What Is The Relationship Between ROE And 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 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.

Ovintiv's Earnings Growth And 19% ROE

To begin with, Ovintiv seems to have a respectable ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 16%. This certainly adds some context to Ovintiv's exceptional 41% net income growth seen over the past five years. However, there could also be other drivers behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing Ovintiv's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 41% over the last few years.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. 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 OVV? You can find out in our latest intrinsic value infographic research report.

Is Ovintiv Using Its Retained Earnings Effectively?

Ovintiv's three-year median payout ratio to shareholders is 7.8%, which is quite low. This implies that the company is retaining 92% of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

Moreover, Ovintiv is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 21% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company's expected ROE (to 13%) over the same period.

Conclusion

In total, we are pretty happy with Ovintiv's 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. That being so, according to the latest industry analyst forecasts, the company's earnings are expected 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.