Phillips 66's (NYSE:PSX) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

With its stock down 9.8% over the past three months, it is easy to disregard Phillips 66 (NYSE:PSX). 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. Specifically, we decided to study Phillips 66's 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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Phillips 66

How Is ROE Calculated?

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 Phillips 66 is:

12% = US$3.4b ÷ US$30b (Based on the trailing twelve months to September 2024).

The 'return' is the amount earned after tax over the last twelve months. That means that for every $1 worth of shareholders' equity, the company generated $0.12 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

Phillips 66's Earnings Growth And 12% ROE

To begin with, Phillips 66 seems to have a respectable ROE. Even so, when compared with the average industry ROE of 15%, we aren't very excited. Still, we can see that Phillips 66 has seen a remarkable net income growth of 39% over the past five years. We reckon that there could be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this also does lend some color to the high earnings growth seen by the company.

As a next step, we compared Phillips 66's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 40% in the same period.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Phillips 66's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Phillips 66 Using Its Retained Earnings Effectively?

The three-year median payout ratio for Phillips 66 is 27%, which is moderately low. The company is retaining the remaining 73%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Phillips 66 is reinvesting its earnings efficiently.

Additionally, Phillips 66 has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 38% over the next three years. Regardless, the future ROE for Phillips 66 is speculated to rise to 16% despite the anticipated increase in the payout ratio. There could probably be other factors that could be driving the future growth in the ROE.

Conclusion

Overall, we are quite pleased with Phillips 66's performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.