Could The Market Be Wrong About Epsilon Energy Ltd. (NASDAQ:EPSN) Given Its Attractive Financial Prospects?

Epsilon Energy (NASDAQ:EPSN) has had a rough month with its share price down 8.9%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Epsilon Energy's ROE in this article.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Epsilon Energy

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Epsilon Energy is:

35% = US$34m ÷ US$96m (Based on the trailing twelve months to September 2022).

The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.35.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

Epsilon Energy's Earnings Growth And 35% ROE

To begin with, Epsilon Energy has a pretty high ROE which is interesting. Additionally, a comparison with the average industry ROE of 32% also portrays the company's ROE in a good light. Given the circumstances, the significant 29% net income growth seen by Epsilon Energy over the last five years is not surprising.

As a next step, we compared Epsilon Energy's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 6.8%.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Epsilon Energy's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Epsilon Energy Using Its Retained Earnings Effectively?

Epsilon Energy has a really low three-year median payout ratio of 11%, meaning that it has the remaining 89% left over to reinvest into its business. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

While Epsilon Energy has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend.

Summary

Overall, we are quite pleased with Epsilon Energy's 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. 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. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. To know the 1 risk we have identified for Epsilon Energy 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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