It is hard to get excited after looking at Middlesex Water's (NASDAQ:MSEX) recent performance, when its stock has declined 4.1% over the past week. 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. Particularly, we will be paying attention to Middlesex Water's 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.

View our latest analysis for Middlesex Water

How Is ROE Calculated?

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 Middlesex Water is:

7.8% = US$33m ÷ US$422m (Based on the trailing twelve months to September 2023).

The 'return' is the income the business earned over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.08.

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. 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. 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 Middlesex Water's Earnings Growth And 7.8% ROE

At first glance, Middlesex Water's ROE doesn't look very promising. However, its ROE is similar to the industry average of 8.1%, so we won't completely dismiss the company. On the other hand, Middlesex Water reported a fairly low 3.6% net income growth over the past five years. Bear in mind, the company's ROE is not very high . So this could also be one of the reasons behind the company's low growth in earnings.

As a next step, we compared Middlesex Water's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 8.9% in the same period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is Middlesex Water fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Middlesex Water Using Its Retained Earnings Effectively?

Despite having a moderate three-year median payout ratio of 49% (implying that the company retains the remaining 51% of its income), Middlesex Water's earnings growth was quite low. Therefore, there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, Middlesex Water has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth.

Summary

In total, we're a bit ambivalent about Middlesex Water's performance. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. You can see the 2 risks we have identified for Middlesex Water by visiting our risks dashboard for free on our platform here.

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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.