It is hard to get excited after looking at Imperial Oil’s (TSE:IMO) recent performance, when its stock has declined 7.8% over the past three months. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Imperial Oil’s ROE.
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 simpler terms, it measures the profitability of a company in relation to shareholder’s equity.
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders’ Equity
So, based on the above formula, the ROE for Imperial Oil is:
32% = CA$7.4b ÷ CA$23b (Based on the trailing twelve months to March 2023).
The ‘return’ is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each CA$1 of shareholders’ capital it has, the company made CA$0.32 in profit.
Why Is ROE Important For Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company’s future earnings. Depending on how much of these profits the company reinvests or “retains”, and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
Imperial Oil’s Earnings Growth And 32% ROE
First thing first, we like that Imperial Oil has an impressive ROE. Additionally, the company’s ROE is higher compared to the industry average of 25% which is quite remarkable. Under the circumstances, Imperial Oil’s considerable five year net income growth of 34% was to be expected.
We then performed a comparison between Imperial Oil’s net income growth with the industry, which revealed that the company’s growth is similar to the average industry growth of 40% in the same period.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for IMO? You can find out in our latest intrinsic value infographic research report.
Is Imperial Oil Efficiently Re-investing Its Profits?
Imperial Oil’s ‘ three-year median payout ratio is on the lower side at 13% implying that it is retaining a higher percentage (87%) of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.
Additionally, Imperial Oil has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts’ consensus data, we found that the company’s future payout ratio is expected to rise to 18% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company’s expected ROE (to 16%) over the same period.
In total, we are pretty happy with Imperial Oil’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. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. Are these analysts expectations based on the broad expectations for the industry, or on the company’s fundamentals? Click here to be taken to our analyst’s forecasts page 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.
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