Could The Market Be Wrong About Diamondback Energy, Inc. (NASDAQ:FANG) Given Its Attractive Financial Prospects?

Diamondback Energy (NASDAQ:FANG) has had a rough month with its share price down 3.0%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Diamondback Energy's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Diamondback Energy

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 Diamondback Energy is:

20% = US$3.7b ÷ US$19b (Based on the trailing twelve months to June 2024).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.20.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

A Side By Side comparison of Diamondback Energy's Earnings Growth And 20% ROE

To begin with, Diamondback Energy seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 16%. This probably laid the ground for Diamondback Energy's significant 46% net income growth seen over the past five years. We reckon that there could also be other factors at play here. Such as - high earnings retention or an efficient management in place.

We then performed a comparison between Diamondback Energy's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 40% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is Diamondback Energy fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Diamondback Energy Efficiently Re-investing Its Profits?

Diamondback Energy has a three-year median payout ratio of 38% (where it is retaining 62% of its income) which is not too low or not too high. So it seems that Diamondback Energy is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Moreover, Diamondback Energy is determined to keep sharing its profits with shareholders which we infer from its long history of seven years of paying a dividend. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 36% of its profits over the next three years. However, Diamondback Energy's future ROE is expected to decline to 12% despite there being not much change anticipated in the company's payout ratio.

Summary

On the whole, we feel that Diamondback 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. 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.