Could The Market Be Wrong About SM Energy Company (NYSE:SM) Given Its Attractive Financial Prospects?
It is hard to get excited after looking at SM Energy's (NYSE:SM) recent performance, when its stock has declined 14% over the past three months. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on SM Energy's ROE.
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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
See our latest analysis for SM Energy
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 SM Energy is:
24% = US$829m ÷ US$3.4b (Based on the trailing twelve months to September 2023).
The 'return' is the amount earned after tax over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.24.
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. 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.
SM Energy's Earnings Growth And 24% ROE
To begin with, SM Energy has a pretty high ROE which is interesting. Even when compared to the industry average of 23% the company's ROE is pretty decent. Therefore, it might not be wrong to say that the impressive five year 41% net income growth seen by SM Energy was probably achieved as a result of the high ROE.
Next, on comparing with the industry net income growth, we found that SM Energy's growth is quite high when compared to the industry average growth of 33% in the same period, which is great to see.
Earnings growth is an important metric to consider when valuing a stock. 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 SM fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is SM Energy Efficiently Re-investing Its Profits?
SM Energy's three-year median payout ratio to shareholders is 0.7%, which is quite low. This implies that the company is retaining 99% of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.
Moreover, SM Energy is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 11% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company's expected ROE (to 17%) over the same period.
Conclusion
Overall, we are quite pleased with SM Energy's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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.
