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Is Weakness In ConocoPhillips (NYSE:COP) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

Simply Wall St


ConocoPhillips (NYSE:COP) has had a rough month with its share price down 7.6%. However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to ConocoPhillips' ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.


Check out our latest analysis for ConocoPhillips

How To Calculate Return On Equity?

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 ConocoPhillips is:

12% = US$3.7b ÷ US$31b (Based on the trailing twelve months to March 2020).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.12 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

ConocoPhillips' Earnings Growth And 12% ROE

To start with, ConocoPhillips' ROE looks acceptable. Even when compared to the industry average of 10.0% the company's ROE looks quite decent. This probably goes some way in explaining ConocoPhillips' significant 50% net income growth over the past five years amongst other factors. We reckon that there could also be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared ConocoPhillips' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 32%.

past-earnings-growth
past-earnings-growth

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about ConocoPhillips''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is ConocoPhillips Efficiently Re-investing Its Profits?

ConocoPhillips' ' three-year median payout ratio is on the lower side at 19% implying that it is retaining a higher percentage (81%) of its profits. So it looks like ConocoPhillips is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Besides, ConocoPhillips has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 80% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 8.2% over the same period.

Conclusion

Overall, we are quite pleased with ConocoPhillips' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.