With its stock down 19% over the past three months, it is easy to disregard Sitio Royalties (NYSE:STR). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Sitio Royalties' ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Sitio Royalties

How To 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 Sitio Royalties is:

1.3% = US$50m ÷ US$3.8b (Based on the trailing twelve months to September 2023).

The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.01 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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.

Sitio Royalties' Earnings Growth And 1.3% ROE

As you can see, Sitio Royalties' ROE looks pretty weak. Not just that, even compared to the industry average of 23%, the company's ROE is entirely unremarkable. Despite this, surprisingly, Sitio Royalties saw an exceptional 40% net income growth over the past five years. Therefore, there could be other reasons behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Sitio Royalties' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 33%.

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. This then helps them determine if the stock is placed for a bright or bleak future. 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 Sitio Royalties is trading on a high P/E or a low P/E, relative to its industry.

Is Sitio Royalties Efficiently Re-investing Its Profits?

Sitio Royalties' three-year median payout ratio is a pretty moderate 29%, meaning the company retains 71% of its income. So it seems that Sitio Royalties is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

While Sitio Royalties has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 217% over the next three years.

Summary

On the whole, we do feel that Sitio Royalties has some positive attributes. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.