ConocoPhillips' (NYSE:COP) stock is up by a considerable 45% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study ConocoPhillips' ROE in this article.
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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How To Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for ConocoPhillips is:
18% = US$8.1b ÷ US$45b (Based on the trailing twelve months to December 2021).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.18 in profit.
Why Is ROE Important For 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
ConocoPhillips' Earnings Growth And 18% ROE
At first glance, ConocoPhillips seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 15%. Consequently, this likely laid the ground for the impressive net income growth of 27% seen over the past five years by ConocoPhillips. However, there could also be other drivers behind this growth. Such as - high earnings retention or an efficient management in place.
When you consider the fact that the industry earnings have shrunk at a rate of 9.7% in the same period, the company's net income growth is pretty remarkable.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 ConocoPhillips is trading on a high P/E or a low P/E, relative to its industry.
Is ConocoPhillips Making Efficient Use Of Its Profits?
ConocoPhillips has a really low three-year median payout ratio of 22%, meaning that it has the remaining 78% left over to reinvest into its business. 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, ConocoPhillips 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. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 27% over the next three years. Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.
In total, we are pretty happy with ConocoPhillips' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. 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.
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.