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Do Its Financials Have Any Role To Play In Driving Peyto Exploration & Development Corp.'s (TSE:PEY) Stock Up Recently?

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Peyto Exploration & Development's (TSE:PEY) stock is up by a considerable 40% over the past three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. In this article, we decided to focus on Peyto Exploration & Development's ROE.

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

Check out our latest analysis for Peyto Exploration & Development

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 Peyto Exploration & Development is:

13% = CA$212m ÷ CA$1.6b (Based on the trailing twelve months to March 2022).

The 'return' is the profit over the last twelve months. So, this means that for every CA$1 of its shareholder's investments, the company generates a profit of CA$0.13.

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. 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.

Peyto Exploration & Development's Earnings Growth And 13% ROE

At first glance, Peyto Exploration & Development seems to have a decent ROE. Yet, the fact that the company's ROE is lower than the industry average of 23% does temper our expectations. Needless to say, the 12% net income shrink rate seen by Peyto Exploration & Developmentover the past five years is a huge dampener. Not to forget, the company does have a high ROE to begin with, just that it is lower than the industry average. Therefore, the shrinking earnings could be the result of other factors. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

However, when we compared Peyto Exploration & Development's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 15% in the same period. This is quite worrisome.

past-earnings-growth
past-earnings-growth

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. If you're wondering about Peyto Exploration & Development's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Peyto Exploration & Development Efficiently Re-investing Its Profits?

When we piece together Peyto Exploration & Development's low three-year median payout ratio of 14% (where it is retaining 86% of its profits), calculated for the last three-year period, we are puzzled by the lack of growth. This typically shouldn't be the case when a company is retaining most of its earnings. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Moreover, Peyto Exploration & Development 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. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 26% over the next three years.

Conclusion

On the whole, we do feel that Peyto Exploration & Development has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a moderate ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 5 risks we have identified for Peyto Exploration & Development by visiting our risks dashboard for free on our platform here.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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