Has Santos Limited (ASX:STO) Stock's Recent Performance Got Anything to Do With Its Financial Health?

Most readers would already know that Santos' (ASX:STO) stock increased by 6.8% over the past three months. 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 Santos' ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Santos

How Do You 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 Santos is:

9.3% = US$1.4b ÷ US$15b (Based on the trailing twelve months to December 2023).

The 'return' is the yearly profit. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.09 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Santos' Earnings Growth And 9.3% ROE

When you first look at it, Santos' ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 15% either. In spite of this, Santos was able to grow its net income considerably, at a rate of 33% in the last 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.

Next, on comparing Santos' net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 33% over the last few years.

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Santos is trading on a high P/E or a low P/E, relative to its industry.

Is Santos Using Its Retained Earnings Effectively?

Santos has a three-year median payout ratio of 40% (where it is retaining 60% of its income) which is not too low or not too high. By the looks of it, the dividend is well covered and Santos is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Besides, Santos has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 55% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.

Conclusion

In total, it does look like Santos has some positive aspects to its business. 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. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com