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Could Woodside Petroleum Ltd's (ASX:WPL) Weak Financials Mean That The Market Could Correct Its Share Price?

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·4 min read
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  • WOPEF
  • WOPEY
  • CL=F

Most readers would already know that Woodside Petroleum's (ASX:WPL) stock increased by 9.0% over the past three months. However, in this article, we decided to focus on its weak financials, as long-term fundamentals ultimately dictate market outcomes. Particularly, we will be paying attention to Woodside Petroleum's ROE today.

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.

Check out our latest analysis for Woodside Petroleum

How Is ROE Calculated?

Return on equity can be calculated by using the formula:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Woodside Petroleum is:

3.1% = US$405m ÷ US$13b (Based on the trailing twelve months to June 2021).

The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.03 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Woodside Petroleum's Earnings Growth And 3.1% ROE

It is quite clear that Woodside Petroleum's ROE is rather low. Even when compared to the industry average of 4.9%, the ROE figure is pretty disappointing. For this reason, Woodside Petroleum's five year net income decline of 49% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

That being said, we compared Woodside Petroleum's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 14% in the same period.

past-earnings-growth
past-earnings-growth

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Woodside Petroleum is trading on a high P/E or a low P/E, relative to its industry.

Is Woodside Petroleum Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 90% (implying that 9.7% of the profits are retained), most of Woodside Petroleum's profits are being paid to shareholders, which explains the company's shrinking earnings. With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. To know the 2 risks we have identified for Woodside Petroleum visit our risks dashboard for free.

Moreover, Woodside Petroleum has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings 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 91%. Regardless, the future ROE for Woodside Petroleum is predicted to rise to 12% despite there being not much change expected in its payout ratio.

Conclusion

Overall, we would be extremely cautious before making any decision on Woodside Petroleum. Particularly, its ROE is a huge disappointment, not to mention its lack of proper reinvestment into the business. As a result its earnings growth has also been quite disappointing. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.

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.