Chevron Corporation's (NYSE:CVX) Has Been On A Rise But Financial Prospects Look Weak: Is The Stock Overpriced?

By
Simply Wall St
Published
October 04, 2021
NYSE:CVX
Source: Shutterstock

Most readers would already be aware that Chevron's (NYSE:CVX) stock increased significantly by 7.0% over the past month. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don't look very promising. In this article, we decided to focus on Chevron's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Chevron

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 Chevron is:

2.7% = US$3.6b ÷ US$134b (Based on the trailing twelve months to June 2021).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.03 in profit.

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.

Chevron's Earnings Growth And 2.7% ROE

It is hard to argue that Chevron's ROE is much good in and of itself. Not just that, even compared to the industry average of 12%, the company's ROE is entirely unremarkable. For this reason, Chevron's five year net income decline of 18% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

That being said, we compared Chevron's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 3.7% in the same period.

past-earnings-growth
NYSE:CVX Past Earnings Growth October 4th 2021

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Has the market priced in the future outlook for CVX? You can find out in our latest intrinsic value infographic research report.

Is Chevron Efficiently Re-investing Its Profits?

Chevron has a high three-year median payout ratio of 59% (that is, it is retaining 41% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. Our risks dashboard should have the 3 risks we have identified for Chevron.

Moreover, Chevron has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 73% over the next three years. Still, forecasts suggest that Chevron's future ROE will rise to 11% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.

Conclusion

In total, we would have a hard think before deciding on any investment action concerning Chevron. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. With that said, we studied the latest analyst forecasts and found that while the company has shrunk its earnings in the past, analysts expect its earnings to grow in the future. 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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