Declining Stock and Solid Fundamentals: Is The Market Wrong About Chevron Corporation (NYSE:CVX)?
It is hard to get excited after looking at Chevron's (NYSE:CVX) recent performance, when its stock has declined 9.3% over the past three months. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Chevron's ROE today.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Put another way, it reveals the company's success at turning shareholder investments into profits.
View our latest analysis for Chevron
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 Chevron is:
22% = US$36b ÷ US$160b (Based on the trailing twelve months to December 2022).
The 'return' refers to a company's earnings over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.22.
What Is The Relationship Between ROE And 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
Chevron's Earnings Growth And 22% ROE
To begin with, Chevron has a pretty high ROE which is interesting. On the other hand, the industry average is quite high at 30%, which tempers our excitement. Chevron was still able to see a decent net income growth of 19% over the past five years. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place. However, not to forget, the company does have a high ROE to begin with, just that it is lower than the industry average. So the high ROE levels also provide some context to the earnings growth seen by the company.
Next, on comparing Chevron's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 16% in the same period.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. Is CVX fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Chevron Using Its Retained Earnings Effectively?
Chevron has a healthy combination of a moderate three-year median payout ratio of 37% (or a retention ratio of 63%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.
Besides, Chevron has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 46% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 15%, over the same period.
On the whole, we feel that Chevron's performance has been quite good. Specifically, we like that it has been reinvesting a high portion of its profits at a moderate rate of return, resulting in earnings expansion. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. 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.
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