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Has Santos Limited's (ASX:STO) Impressive Stock Performance Got Anything to Do With Its Fundamentals?

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Santos (ASX:STO) has had a great run on the share market with its stock up by a significant 21% over the last month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Santos' ROE.

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 Santos

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 Santos is:

3.9% = US$286m ÷ US$7.3b (Based on the trailing twelve months to June 2021).

The 'return' is the yearly profit. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.04.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Santos' Earnings Growth And 3.9% ROE

When you first look at it, Santos' ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 4.9% either. In spite of this, Santos was able to grow its net income considerably, at a rate of 60% in the last five years. Therefore, there could be other reasons behind this growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Santos' growth is quite high when compared to the industry average growth of 14% in the same period, which is great to see.

past-earnings-growth
past-earnings-growth

Earnings growth is an important metric to consider when valuing a stock. 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 Santos fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Santos Efficiently Re-investing Its Profits?

The three-year median payout ratio for Santos is 30%, which is moderately low. The company is retaining the remaining 70%. By the looks of it, the dividend is well covered and Santos is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Additionally, Santos 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 is expected to keep paying out approximately 28% of its profits over the next three years. Still, forecasts suggest that Santos' future ROE will rise to 10% even though the the company's payout ratio is not expected to change by much.

Conclusion

In total, it does look like Santos has some positive aspects to its business. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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