I am writing today to help inform people who are new to the stock market and want a simplistic look at the return on Exxon Mobil Corporation (NYSE:XOM) stock.
Exxon Mobil Corporation (NYSE:XOM) delivered an ROE of 10.54% over the past 12 months, which is relatively in-line with its industry average of 11.20% during the same period. But what is more interesting is whether XOM can sustain or improve on this level of return. I will take you through how metrics such as financial leverage impact ROE which may affect the overall sustainability of XOM’s returns. See our latest analysis for Exxon Mobil
What you must know about ROE
Return on Equity (ROE) weighs Exxon Mobil’s profit against the level of its shareholders’ equity. An ROE of 10.54% implies $0.11 returned on every $1 invested, so the higher the return, the better. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Integrated Oil and Gas sector by choosing the highest returning stock. However, this can be deceiving as each company has varying costs of equity and debt levels, which could exaggeratedly push up ROE at the same time as accumulating high interest expense.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is assessed against cost of equity, which is measured using the Capital Asset Pricing Model (CAPM) – but let’s not dive into the details of that today. For now, let’s just look at the cost of equity number for Exxon Mobil, which is 9.15%. Exxon Mobil’s ROE exceeds its cost by 1.39%, which is a big tick. Some of its peers with higher ROE may face a cost which exceeds returns, which is unsustainable and far less desirable than Exxon Mobil’s case of positive discrepancy. ROE can be split up into three useful ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
The first component is profit margin, which measures how much of sales is retained after the company pays for all its expenses. The other component, asset turnover, illustrates how much revenue Exxon Mobil can make from its asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable the company’s capital structure is. ROE can be inflated by disproportionately high levels of debt. This is also unsustainable due to the high interest cost that the company will also incur. Thus, we should look at Exxon Mobil’s debt-to-equity ratio to examine sustainability of its returns. The ratio currently stands at a sensible 20.84%, meaning Exxon Mobil has not taken on excessive debt to drive its returns. The company is able to produce profit growth without a huge debt burden and still has headroom to grow returns to industry average.
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. While Exxon Mobil exhibits a weak ROE against its peers, its returns are sufficient enough to cover its cost of equity. Also, ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of returns, which has headroom to increase further. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.
For Exxon Mobil, I’ve compiled three relevant aspects you should further research:
- Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
- Valuation: What is Exxon Mobil worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether Exxon Mobil is currently mispriced by the market.
- Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Exxon Mobil? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!