Are Robust Financials Driving The Recent Rally In Diamondback Energy, Inc.'s (NASDAQ:FANG) Stock?
Most readers would already be aware that Diamondback Energy's (NASDAQ:FANG) stock increased significantly by 21% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Specifically, we decided to study Diamondback Energy's ROE in this article.
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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.
Check out our latest analysis for Diamondback Energy
How Do You Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Diamondback Energy is:
19% = US$3.3b ÷ US$17b (Based on the trailing twelve months to December 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 $0.19.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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.
A Side By Side comparison of Diamondback Energy's Earnings Growth And 19% ROE
To begin with, Diamondback Energy seems to have a respectable ROE. Even when compared to the industry average of 21% the company's ROE looks quite decent. This certainly adds some context to Diamondback Energy's exceptional 42% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.
Next, on comparing Diamondback Energy's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 36% over the last few years.
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). This then helps them determine if the stock is placed for a bright or bleak future. 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 Diamondback Energy is trading on a high P/E or a low P/E, relative to its industry.
Is Diamondback Energy Making Efficient Use Of Its Profits?
Diamondback Energy has a three-year median payout ratio of 36% (where it is retaining 64% of its income) which is not too low or not too high. So it seems that Diamondback Energy is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.
Moreover, Diamondback Energy is determined to keep sharing its profits with shareholders which we infer from its long history of six years of paying a dividend. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 41% of its profits over the next three years. Still, forecasts suggest that Diamondback Energy's future ROE will drop to 12% even though the the company's payout ratio is not expected to change by much.
Summary
In total, we are pretty happy with Diamondback 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, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.
