California Resources Corporation's (NYSE:CRC) Stock Is Going Strong: Have Financials A Role To Play?

California Resources (NYSE:CRC) has had a great run on the share market with its stock up by a significant 18% over the last three months. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study California Resources' ROE in this article.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for California Resources

How Do You 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 California Resources is:

8.0% = US$164m ÷ US$2.1b (Based on the trailing twelve months to June 2024).

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 $0.08 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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.

California Resources' Earnings Growth And 8.0% ROE

At first glance, California Resources' ROE doesn't look very promising. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 15% either. Although, we can see that California Resources saw a modest net income growth of 12% over the past five years. So, the growth in the company's earnings could probably have been caused by other variables. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared California Resources' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 39% 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 CRC fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is California Resources Using Its Retained Earnings Effectively?

In California Resources' case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 8.1% (or a retention ratio of 92%), which suggests that the company is investing most of its profits to grow its business.

Moreover, California Resources is determined to keep sharing its profits with shareholders which we infer from its long history of three years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 35% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to -3.5%, over the same period.

Conclusion

In total, it does look like California Resources has some positive aspects to its business. Namely, its respectable earnings growth, which it achieved due to it retaining most of its profits. However, given the low ROE, investors may not be benefitting from all that reinvestment after all. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.