With An ROE Of 9.26%, Can Diamondback Energy Inc (NASDAQ:FANG) Catch Up To The Industry?
Diamondback Energy Inc (NASDAQ:FANG) generated a below-average return on equity of 9.26% in the past 12 months, while its industry returned 10.80%. An investor may attribute an inferior ROE to a relatively inefficient performance, and whilst this can often be the case, knowing the nuts and bolts of the ROE calculation may change that perspective and give you a deeper insight into FANG’s past performance. Metrics such as financial leverage can impact the level of ROE which in turn can affect the sustainability of FANG’s returns. Let me show you what I mean by this. View our latest analysis for Diamondback Energy
Breaking down ROE — the mother of all ratios
Return on Equity (ROE) is a measure of Diamondback Energy’s profit relative to its shareholders’ equity. For example, if the company invests $1 in the form of equity, it will generate $0.09 in earnings from this. While a higher ROE is preferred in most cases, there are several other factors we should consider before drawing any conclusions.
Return on Equity = Net Profit ÷ Shareholders Equity
ROE is measured against cost of equity in order to determine the efficiency of Diamondback Energy’s equity capital deployed. Its cost of equity is 9.34%. Given a discrepancy of -0.078% between return and cost, this indicated that Diamondback Energy may be paying more for its capital than what it’s generating in return. ROE can be split up into three useful ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:
Dupont Formula
ROE = profit margin × asset turnover × financial leverage
ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)
ROE = annual net profit ÷ shareholders’ equity
Essentially, profit margin shows how much money the company makes after paying for all its expenses. The other component, asset turnover, illustrates how much revenue Diamondback Energy can make from its asset base. Finally, financial leverage will be our main focus today. It shows how much of assets are funded by equity and can show how sustainable the company’s capital structure is. Since financial leverage can artificially inflate ROE, we need to look at how much debt Diamondback Energy currently has. The debt-to-equity ratio currently stands at a low 26.47%, meaning Diamondback Energy still has headroom to borrow debt to increase profits.
Next Steps:
ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Diamondback Energy’s below-industry ROE is disappointing, furthermore, its returns were not even high enough to cover its own cost of equity. Although, its appropriate level of leverage means investors can be more confident in the sustainability of Diamondback Energy’s return with a possible increase should the company decide to increase its debt levels. Although ROE can be a useful metric, it is only a small part of diligent research.
For Diamondback Energy, there are three fundamental aspects you should look at:
Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
Valuation: What is Diamondback Energy worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether Diamondback Energy is currently mispriced by the market.
Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Diamondback Energy? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!
To help readers see pass the short term volatility of the financial market, we aim to bring you a long-term focused research analysis purely driven by fundamental data. Note that our analysis does not factor in the latest price sensitive company announcements.
The author is an independent contributor and at the time of publication had no position in the stocks mentioned.
