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With its stock down 9.6% over the past month, it is easy to disregard Exxon Mobil (NYSE:XOM). To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. Particularly, we will be paying attention to Exxon Mobil's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Is ROE Calculated?
ROE 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 Exxon Mobil is:
6.1% = US$12b ÷ US$189b (Based on the trailing twelve months to March 2020).
The 'return' is the yearly profit. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.06 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learnt 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
A Side By Side comparison of Exxon Mobil's Earnings Growth And 6.1% ROE
At first glance, Exxon Mobil's ROE doesn't look very promising. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 10%. For this reason, Exxon Mobil's five year net income decline of 2.4% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.
That being said, we compared Exxon Mobil'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 33% in the same period.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Is XOM fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Exxon Mobil Making Efficient Use Of Its Profits?
With a high three-year median payout ratio of 80% (implying that 20% of the profits are retained), most of Exxon Mobil'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 3 risks we have identified for Exxon Mobil visit our risks dashboard for free.
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. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 99% over the next three years. However, the company's ROE is not expected to change by much despite the higher expected payout ratio.
On the whole, Exxon Mobil's performance is quite a big let-down. The company has seen a lack of earnings growth as a result of retaining very little profits and whatever little it does retain, is being reinvested at a very low rate of return. 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. 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. 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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