It is hard to get excited after looking at Select Water Solutions' (NYSE:WTTR) recent performance, when its stock has declined 7.3% over the past month. However, stock prices are usually driven by a company's financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Select Water Solutions' ROE today.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How Is ROE Calculated?

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 Select Water Solutions is:

6.8% = US$62m ÷ US$902m (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.07 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

Select Water Solutions' Earnings Growth And 6.8% ROE

At first glance, Select Water Solutions' ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 13%. In spite of this, Select Water Solutions was able to grow its net income considerably, at a rate of 54% in the last five years. Therefore, there could be other reasons behind this 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 performed a comparison between Select Water Solutions' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 48% in the same 5-year 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. This then helps them determine if the stock is placed for a bright or bleak future. Is Select Water Solutions fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Select Water Solutions Using Its Retained Earnings Effectively?

The three-year median payout ratio for Select Water Solutions is 31%, which is moderately low. The company is retaining the remaining 69%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Select Water Solutions is reinvesting its earnings efficiently.

While Select Water Solutions 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 drop to 18% over the next three years. As a result, the expected drop in Select Water Solutions' payout ratio explains the anticipated rise in the company's future ROE to 14%, over the same period.

Summary

Overall, we feel that Select Water Solutions certainly does have some positive factors to consider. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. 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.