With its stock down 7.7% over the past month, it is easy to disregard Baker Hughes (NASDAQ:BKR). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Baker Hughes' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Baker Hughes

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 Baker Hughes is:

18% = US$3.0b ÷ US$17b (Based on the trailing twelve months to December 2024).

The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.18 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 Baker Hughes' Earnings Growth And 18% ROE

At first glance, Baker Hughes seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 13%. This certainly adds some context to Baker Hughes' exceptional 78% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings 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.

Next, on comparing with the industry net income growth, we found that Baker Hughes' growth is quite high when compared to the industry average growth of 56% in the same period, which is great to see.

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. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for BKR? You can find out in our latest intrinsic value infographic research report.

Is Baker Hughes Making Efficient Use Of Its Profits?

Baker Hughes has a three-year median payout ratio of 37% (where it is retaining 63% of its income) which is not too low or not too high. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Baker Hughes is reinvesting its earnings efficiently.

Moreover, Baker Hughes is determined to keep sharing its profits with shareholders which we infer from its long history of eight years of paying a dividend. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 31%. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 16%.

Conclusion

In total, we are pretty happy with Baker Hughes' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.

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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.