Is Weakness In Shell plc (LON:SHEL) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

Shell (LON:SHEL) has had a rough three months with its share price down 3.6%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on Shell's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

View our latest analysis for Shell

How Is ROE Calculated?

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 Shell is:

23% = US$44b ÷ US$196b (Based on the trailing twelve months to March 2023).

The 'return' is the yearly profit. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.23.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

A Side By Side comparison of Shell's Earnings Growth And 23% ROE

First thing first, we like that Shell has an impressive ROE. Secondly, even when compared to the industry average of 16% the company's ROE is quite impressive. This likely paved the way for the modest 14% net income growth seen by Shell over the past five years. growth

Next, on comparing with the industry net income growth, we found that Shell's reported growth was lower than the industry growth of 21% in the same period, which is not something we like to see.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for SHEL? You can find out in our latest intrinsic value infographic research report.

Is Shell Using Its Retained Earnings Effectively?

Shell's three-year median payout ratio to shareholders is 18% (implying that it retains 82% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

Additionally, Shell has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 32% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company's expected ROE (to 11%) over the same period.

Conclusion

In total, we are pretty happy with Shell's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. As a result, the decent growth in its earnings is not surprising. 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. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.