It’s hard to get excited after looking at the recent performance of Saudi Arabian Oil (TADAWUL: 2222), as its stock has fallen 6.0% in the past month. However, stock prices are usually determined by a company’s long-term financials, which in this case looks pretty respectable. In this article, we have decided to focus on the ROE of Saudi Arabian Oil.
Return on equity or ROE is a test of how effectively a company increases its value and manages investor money. In simpler terms, it measures a company’s profitability relative to equity.
Check out our latest analysis for Saudi oil
How do you calculate return on equity?
the return on equity formula is:
Return on equity = Net income (from continuing operations) Ã· Equity
So, based on the above formula, the ROE of Saudi oil is:
28% = Ø±.Ø³ 343 b Ã· Ø±.Ø³ 1.2 t (Based on the last twelve months up to September 2021).
“Return” refers to a company’s profits over the past year. One way to conceptualize this is that for every SAR1 of shareholders’ capital it has, the company made SAR0.28 in profit.
What is the relationship between ROE and profit growth?
So far, we’ve learned that ROE is a measure of a company’s profitability. We now need to assess the profits that the business is reinvesting or âwithholdingâ for future growth, which then gives us an idea of ââthe growth potential of the business. Assuming everything else remains the same, the higher the ROE and profit retention, the higher the growth rate of a business compared to businesses that don’t necessarily have these characteristics.
Saudi Oil Profit Growth and 28% ROE
At first glance, Saudi oil seems to have a decent ROE. Additionally, the company’s ROE compares quite favorably to the industry average of 17%. Yet Saudi oil has shown meager growth of 2.9% over the past five years. This is usually not the case, because when a business has a high rate of return, it should generally also have a high rate of profit growth. Some likely reasons why this could happen are that the business might have a high payout rate or the business has misallocated capital, for example.
Then, comparing the net income growth of Saudi Arabian Oil with the industry, we found that the reported growth of the company is similar to the industry average growth rate of 2.9% during the same period. .
The basis for attaching value to a business is, to a large extent, related to the growth of its profits. What investors next need to determine is whether the expected earnings growth, or lack thereof, is already built into the share price. This will help them determine whether the future of the stock looks bright or threatening. If you’re wondering about the valuation of Saudi Arabian Oil, check out this gauge of its price / earnings ratio, relative to its industry.
Is Saudi Oil Using Profits Efficiently?
The high 96% three-year median payout rate (i.e. the company only keeps 4.2% of its revenue) over the past three years for Saudi Arabian Oil suggests that earnings growth of the company was lower due to the disbursement of a majority of its earnings.
Moreover, Saudi oil only started paying a dividend recently. So it seems that management must have perceived that shareholders prefer dividends to earnings growth. After studying the latest consensus data from analysts, we found that the company’s future payout ratio is expected to drop to 73% over the next three years. However, the company’s ROE is not expected to change much despite the expected lower payout ratio.
Overall, we believe Saudi oil has positive attributes. The company increased its profits moderately due to its impressive ROE. Yet the company keeps virtually none of its profits. This could have negative implications for the future growth of the business. The latest forecasts from industry analysts show the company is expected to maintain its current growth rate. Are the expectations of these analysts based on general industry expectations or on company fundamentals? Click here to go to our business analyst forecasts page.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only 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 into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.