Most readers would already be aware that Exxon Mobil's (NYSE:XOM) stock increased significantly by 16% over the past 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 Exxon Mobil's ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
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 Exxon Mobil is:
28% = US$54b ÷ US$193b (Based on the trailing twelve months to September 2022).
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 $0.28 in profit.
What Has ROE Got To Do With 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
Exxon Mobil's Earnings Growth And 28% ROE
Firstly, we acknowledge that Exxon Mobil has a significantly high ROE. Additionally, a comparison with the average industry ROE of 31% also portrays the company's ROE in a good light. However, When you compare Exxon Mobil's high ROE with its rather flat earnings, you are left wondering, what's causing the growth to lag? Therefore, there could be some other aspects that could potentially be preventing the company from growing. For example, it could be that the company has a high payout ratio or the the business has allocated capital poorly, for instance.
We then compared Exxon Mobil's net income growth with the industry and found that the average industry growth rate was 6.3% in the same period.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is XOM fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Exxon Mobil Using Its Retained Earnings Effectively?
With a high three-year median payout ratio of 58% (implying that the company keeps only 42% of its income) of its business to reinvest into its business), most of Exxon Mobil's profits are being paid to shareholders, which explains the absence of growth in earnings.
In addition, Exxon Mobil has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 47%. Regardless, Exxon Mobil's ROE is speculated to decline to 15% despite there being no anticipated change in its payout ratio.
In total, it does look like Exxon Mobil has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. Moreover, after studying current analyst estimates, we discovered that the company's earnings are expected to continue to shrink in the future. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.
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.
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