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Most readers would already be aware that ConocoPhillips' (NYSE:COP) stock increased significantly by 39% 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 ConocoPhillips' ROE in this article.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.
Check out our latest analysis for ConocoPhillips
How Is ROE Calculated?
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 ConocoPhillips is:
18% = US$8.1b ÷ US$45b (Based on the trailing twelve months to December 2021).
The 'return' is the yearly profit. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.18 in profit.
Why Is ROE Important For Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
A Side By Side comparison of ConocoPhillips' Earnings Growth And 18% ROE
To begin with, ConocoPhillips seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 15%. This certainly adds some context to ConocoPhillips' exceptional 27% net income growth seen over the past five years. However, there could also be other causes behind this growth. Such as - high earnings retention or an efficient management in place.
When you consider the fact that the industry earnings have shrunk at a rate of 11% in the same period, the company's net income growth is pretty remarkable.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about ConocoPhillips''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.