Is Saudi Arabian Oil Company's (TADAWUL:2222) Stock's Recent Performance Being Led By Its Attractive Financial Prospects?

Saudi Arabian Oil (TADAWUL:2222) has had a great run on the share market with its stock up by a significant 12% over the last month. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Saudi Arabian Oil's ROE.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Saudi Arabian Oil

How To 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 Saudi Arabian Oil is:

36% = ر.س604b ÷ ر.س1.7t (Based on the trailing twelve months to December 2022).

The 'return' is the income the business earned over the last year. That means that for every SAR1 worth of shareholders' equity, the company generated SAR0.36 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

Saudi Arabian Oil's Earnings Growth And 36% ROE

First thing first, we like that Saudi Arabian Oil has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 13% also doesn't go unnoticed by us. This probably laid the groundwork for Saudi Arabian Oil's moderate 11% net income growth seen over the past five years.

Next, on comparing Saudi Arabian 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 11% in the same period.

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. This then helps them determine if the stock is placed for a bright or bleak future. 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 Saudi Arabian Oil is trading on a high P/E or a low P/E, relative to its industry.

Is Saudi Arabian Oil Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 64% (or a retention ratio of 36%) for Saudi Arabian Oil suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Besides, Saudi Arabian Oil has been paying dividends over a period of three years. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 64% of its profits over the next three years. Regardless, Saudi Arabian Oil's ROE is speculated to decline to 26% despite there being no anticipated change in its payout ratio.

Conclusion

On the whole, we feel that Saudi Arabian Oil's performance has been quite good. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. 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 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.