Declining Stock and Solid Fundamentals: Is The Market Wrong About Cenovus Energy Inc. (TSE:CVE)?

With its stock down 10% over the past month, it is easy to disregard Cenovus Energy (TSE:CVE). 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 Cenovus 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 Cenovus Energy

How To Calculate Return On Equity?

Return on equity 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 Cenovus Energy is:

11% = CA$3.1b ÷ CA$30b (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 CA$1 worth of equity, the company was able to earn CA$0.11 in profit.

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. 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 Cenovus Energy's Earnings Growth And 11% ROE

At first glance, Cenovus Energy seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 11%. Consequently, this likely laid the ground for the impressive net income growth of 43% seen over the past five years by Cenovus Energy. However, there could also be other drivers behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then performed a comparison between Cenovus Energy's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 38% in the same 5-year period.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Cenovus Energy's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Cenovus Energy Using Its Retained Earnings Effectively?

Cenovus Energy has a really low three-year median payout ratio of 24%, meaning that it has the remaining 76% 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, Cenovus Energy is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 33% over the next three years. Regardless, the future ROE for Cenovus Energy is speculated to rise to 14% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.

Summary

On the whole, we feel that Cenovus Energy's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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 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.