Select Water Solutions (NYSE:WTTR) has had a great run on the share market with its stock up by a significant 21% over the last three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Specifically, we decided to study Select Water Solutions' ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Select Water Solutions

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 Select Water Solutions is:

7.1% = US$65m ÷ US$919m (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.07 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. 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 Select Water Solutions' Earnings Growth And 7.1% ROE

At first glance, Select Water Solutions' ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 14% either. Despite this, surprisingly, Select Water Solutions saw an exceptional 62% net income growth over the past five years. Therefore, there could be other reasons behind this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

We then performed a comparison between Select Water Solutions' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 52% in the same 5-year period.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Is WTTR fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Select Water Solutions Using Its Retained Earnings Effectively?

Select Water Solutions has a three-year median payout ratio of 33% (where it is retaining 67% of its income) which is not too low or not too high. So it seems that Select Water Solutions is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Along with seeing a growth in earnings, Select Water Solutions 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 drop to 16% over the next three years. The fact that the company's ROE is expected to rise to 16% over the same period is explained by the drop in the payout ratio.

Conclusion

On the whole, we do feel that Select Water Solutions has some positive attributes. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. We also studied the latest analyst forecasts and found that the company's earnings growth is expected be similar to its current growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.