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Is Weakness In ARC Resources Ltd. (TSE:ARX) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

With its stock down 8.7% over the past three months, it is easy to disregard ARC Resources (TSE:ARX). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to ARC Resources' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for ARC Resources

How Do You Calculate Return On Equity?

Return on equity can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

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So, based on the above formula, the ROE for ARC Resources is:

26% = CA$1.8b ÷ CA$7.1b (Based on the trailing twelve months to September 2023).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each CA$1 of shareholders' capital it has, the company made CA$0.26 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

ARC Resources' Earnings Growth And 26% ROE

Firstly, we acknowledge that ARC Resources has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 17% also doesn't go unnoticed by us. As a result, ARC Resources' exceptional 63% net income growth seen over the past five years, doesn't come as a surprise.

We then compared ARC Resources' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 42% in the same 5-year period.

past-earnings-growth
TSX:ARX Past Earnings Growth January 20th 2024

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 ARX fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is ARC Resources Using Its Retained Earnings Effectively?

ARC Resources' ' three-year median payout ratio is on the lower side at 19% implying that it is retaining a higher percentage (81%) of its profits. So it looks like ARC Resources is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Moreover, ARC Resources is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 19%. Still, forecasts suggest that ARC Resources' future ROE will drop to 18% even though the the company's payout ratio is not expected to change by much.

Conclusion

In total, we are pretty happy with ARC Resources' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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.