Most readers would already know that Middlesex Water's (NASDAQ:MSEX) stock increased by 8.1% over the past three months. However, in this article, we decided to focus on its weak financials, as long-term fundamentals ultimately dictate market outcomes. Particularly, we will be paying attention to Middlesex Water's ROE today.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

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 Middlesex Water is:

9.3% = US$41m ÷ US$444m (Based on the trailing twelve months to September 2024).

The 'return' is the profit over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.09 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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.

Middlesex Water's Earnings Growth And 9.3% ROE

When you first look at it, Middlesex Water's ROE doesn't look that attractive. However, its ROE is similar to the industry average of 9.3%, so we won't completely dismiss the company. Still, Middlesex Water has seen a flat net income growth over the past five years. Bear in mind, the company's ROE is not very high. So that could also be one of the reasons behind the company's flat 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 9.9% in the same 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Middlesex Water's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Middlesex Water Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 56% (meaning, the company retains only 44% of profits) for Middlesex Water suggests that the company's earnings growth was miniscule as a result of paying out a majority of its earnings.

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

Overall, we would be extremely cautious before making any decision on Middlesex Water. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. Up till now, we've only made a short study of the company's growth data. To gain further insights into Middlesex Water's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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.