BHP Group's (ASX:BHP) stock up by 2.4% over the past week. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study BHP Group's ROE in this article.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for BHP Group

How Is ROE Calculated?

ROE 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 BHP Group is:

30% = US$14b ÷ US$49b (Based on the trailing twelve months to June 2023).

The 'return' is the profit over the last twelve months. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.30.

What Is The Relationship Between ROE And 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. 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.

BHP Group's Earnings Growth And 30% ROE

First thing first, we like that BHP Group has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 10% also doesn't go unnoticed by us. This likely paved the way for the modest 20% net income growth seen by BHP Group over the past five years.

We then performed a comparison between BHP Group's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 23% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. 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. Is BHP fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is BHP Group Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 92% (or a retention ratio of 7.6%) for BHP Group suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Besides, BHP Group has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 57% over the next three years. However, BHP Group's future ROE is expected to decline to 23% despite the expected decline in its payout ratio. We infer that there could be other factors that could be steering the foreseen decline in the company's ROE.

Summary

In total, it does look like BHP Group has some positive aspects to its business. Namely, its high earnings growth, which was likely due to its high ROE. However, investors could have benefitted even more from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining hardly any of its profits. 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.