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BHP Group Limited's (ASX:BHP) Stock Is Going Strong: Have Financials A Role To Play?

BHP Group's (ASX:BHP) stock is up by a considerable 12% over the past month. 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.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for BHP Group

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 BHP Group is:

46% = US$22b ÷ US$49b (Based on the trailing twelve months to June 2022).

The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.46 in profit.

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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

A Side By Side comparison of BHP Group's Earnings Growth And 46% ROE

Firstly, we acknowledge that BHP Group has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 16% also doesn't go unnoticed by us. As a result, BHP Group's exceptional 23% net income growth seen over the past five years, doesn't come as a surprise.

As a next step, we compared BHP Group'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 33% in the same period.

past-earnings-growth
past-earnings-growth

Earnings growth is an important metric to consider when valuing a stock. 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. Has the market priced in the future outlook for BHP? You can find out in our latest intrinsic value infographic research report.

Is BHP Group Making Efficient Use Of Its Profits?

BHP Group has a significant three-year median payout ratio of 92%, meaning the company only retains 7.6% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.

Moreover, BHP Group 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. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 66% over the next three years. Still forecasts suggest that BHP Group's future ROE will drop to 24% even though the the company's payout ratio is expected to decrease. This suggests that there could be other factors could driving the anticipated decline in the company's ROE.

Summary

On the whole, we do feel that BHP Group has some positive attributes. Its earnings have grown respectably as we saw earlier, probably due to its high returns. However, it does reinvest little to almost none of its profits, so we wonder what effect this could have on its future growth prospects. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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