Most readers would already know that BHP Group's (ASX:BHP) stock increased by 4.6% over the past week. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to investigate if the company's decent financials had a hand to play in the recent price move. Particularly, we will be paying attention to BHP Group's 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.

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How To Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for BHP Group is:

27% = US$13b ÷ US$50b (Based on the trailing twelve months to December 2024).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.27 in profit.

See our latest analysis for BHP Group

What Has ROE Got To Do With 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.

BHP Group's Earnings Growth And 27% ROE

First thing first, we like that BHP Group has an impressive ROE. Secondly, even when compared to the industry average of 12% the company's ROE is quite impressive. Despite this, BHP Group's five year net income growth was quite low averaging at only 2.3%. That's a bit unexpected from a company which has such a high rate of return. A few likely reasons why this could happen is that the company could have a high payout ratio or the business has allocated capital poorly, for instance.

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 20% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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. What is BHP worth today? The intrinsic value infographic in our free research report helps visualize whether BHP is currently mispriced by the market.

Is BHP Group Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 80% (or a retention ratio of 20%), most of BHP Group's profits are being paid to shareholders. This definitely contributes to the low earnings growth seen by the company.

Additionally, BHP Group has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 51% over the next three years. Still forecasts suggest that BHP Group's future ROE will drop to 17% 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.

Conclusion

In total, it does look like BHP Group has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. 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. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.