Northern Oil and Gas' (NYSE:NOG) stock is up by a considerable 16% over the past month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Northern Oil and Gas' ROE.

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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How Is ROE Calculated?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Northern Oil and Gas is:

45% = US$923m ÷ US$2.0b (Based on the trailing twelve months to December 2023).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.45 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. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company's earnings growth potential. 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.

Northern Oil and Gas' Earnings Growth And 45% ROE

First thing first, we like that Northern Oil and Gas has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 21% also doesn't go unnoticed by us. Under the circumstances, Northern Oil and Gas' considerable five year net income growth of 41% was to be expected.

Next, on comparing Northern Oil and Gas' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 37% over the last few years.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is NOG fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Northern Oil and Gas Using Its Retained Earnings Effectively?

Northern Oil and Gas has a really low three-year median payout ratio of 6.7%, meaning that it has the remaining 93% left over to reinvest into its business. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

Moreover, Northern Oil and Gas is determined to keep sharing its profits with shareholders which we infer from its long history of three years of paying a dividend. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 31% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company's expected ROE (to 17%) over the same period.

Conclusion

Overall, we are quite pleased with Northern Oil and Gas' performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. 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. 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.