Parex Resources Inc.'s (TSE:PXT) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

·4 min read

With its stock down 23% over the past three months, it is easy to disregard Parex Resources (TSE:PXT). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Parex Resources' ROE in this article.

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.

Check out our latest analysis for Parex Resources

How Do You Calculate Return On Equity?

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 Parex Resources is:

30% = US$460m ÷ US$1.5b (Based on the trailing twelve months to June 2022).

The 'return' is the profit over the last twelve months. That means that for every CA$1 worth of shareholders' equity, the company generated CA$0.30 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

A Side By Side comparison of Parex Resources' Earnings Growth And 30% ROE

First thing first, we like that Parex Resources has an impressive ROE. Further, even comparing with the industry average if 27%, the company's ROE is quite respectable. So, Parex Resources' moderate 9.8% growth over the past five years was probably backed by the high ROE.

We then compared Parex Resources' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 26% in the same period, which is a bit concerning.

past-earnings-growth
past-earnings-growth

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. 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 Parex Resources is trading on a high P/E or a low P/E, relative to its industry.

Is Parex Resources Using Its Retained Earnings Effectively?

Parex Resources' three-year median payout ratio to shareholders is 8.7% (implying that it retains 91% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Along with seeing a growth in earnings, Parex Resources only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 13% over the next three years.

Summary

On the whole, we feel that Parex Resources' performance has been quite good. 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 a good amount of growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. To know the 1 risk we have identified for Parex Resources visit our risks dashboard for free.

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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