Are Saudi Arabian Oil Company's (TADAWUL:2222) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

With its stock down 4.3% over the past three months, it is easy to disregard Saudi Arabian Oil (TADAWUL:2222). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Saudi Arabian Oil's 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Saudi Arabian Oil

How To Calculate Return On Equity?

ROE 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 Saudi Arabian Oil is:

25% = ر.س434b ÷ ر.س1.7t (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every SAR1 worth of equity, the company was able to earn SAR0.25 in profit.

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.

Saudi Arabian Oil's Earnings Growth And 25% ROE

At first glance, Saudi Arabian Oil seems to have a decent ROE. On comparing with the average industry ROE of 12% the company's ROE looks pretty remarkable. This certainly adds some context to Saudi Arabian Oil's decent 13% net income growth seen over the past five years.

We then compared Saudi Arabian Oil's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 20% in the same 5-year period, which is a bit concerning.

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. This then helps them determine if the stock is placed for a bright or bleak future. Is Saudi Arabian Oil fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Saudi Arabian Oil Using Its Retained Earnings Effectively?

Saudi Arabian Oil has a significant three-year median payout ratio of 71%, meaning that it is left with only 29% to reinvest into its business. This implies that the company has been able to achieve decent earnings growth despite returning most of its profits to shareholders.

Besides, Saudi Arabian Oil has been paying dividends over a period of five years. 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 86% over the next three years. Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.

Conclusion

Overall, we feel that Saudi Arabian Oil certainly does have some positive factors to consider. The company has grown its earnings moderately as previously discussed. Still, the high ROE could have been even more beneficial to investors had the company been reinvesting more of its profits. As highlighted earlier, the current reinvestment rate appears to be quite low. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.