Imperial Oil Limited's (TSE:IMO) Stock Is Going Strong: Is the Market Following Fundamentals?

Imperial Oil (TSE:IMO) has had a great run on the share market with its stock up by a significant 11% over the last month. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Particularly, we will be paying attention to Imperial Oil's ROE today.

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.

View our latest analysis for Imperial Oil

How Do You 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 Imperial Oil is:

22% = CA$5.3b ÷ CA$24b (Based on the trailing twelve months to June 2024).

The 'return' is the yearly profit. Another way to think of that is that for every CA$1 worth of equity, the company was able to earn CA$0.22 in profit.

Why Is ROE Important For 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.

Imperial Oil's Earnings Growth And 22% ROE

To begin with, Imperial Oil seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 9.7%. This certainly adds some context to Imperial Oil's exceptional 35% net income growth seen over the past five years. We reckon that there could also be other factors at play here. 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 Imperial Oil's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 38% over the last few years.

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. Is IMO fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Imperial Oil Using Its Retained Earnings Effectively?

Imperial Oil's three-year median payout ratio to shareholders is 21%, which is quite low. This implies that the company is retaining 79% of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Moreover, Imperial Oil 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. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 31% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 16%, over the same period.

Summary

Overall, we are quite pleased with Imperial Oil's 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.