Could The Market Be Wrong About Chevron Corporation (NYSE:CVX) Given Its Attractive Financial Prospects?

With its stock down 8.3% over the past three months, it is easy to disregard Chevron (NYSE:CVX). 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 Chevron's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Chevron

How To Calculate Return On Equity?

Return on equity 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 Chevron is:

22% = US$36b ÷ US$160b (Based on the trailing twelve months to March 2023).

The 'return' refers to a company's earnings over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.22.

What Is The Relationship Between ROE And 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. 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.

Chevron's Earnings Growth And 22% ROE

First thing first, we like that Chevron has an impressive ROE. However, a comparison to the industry average of 33% stops us from getting too excited. However, we are pleased to see the impressive 25% net income growth reported by Chevron over the past five years. So, there might be other aspects that are positively influencing the company's earnings growth. 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. However, not to forget, the company does have a high ROE to begin with, just that it is lower than the industry average. So the high ROE levels also provide some context to the high earnings growth seen by the company.

Next, on comparing with the industry net income growth, we found that Chevron's growth is quite high when compared to the industry average growth of 21% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. 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. Has the market priced in the future outlook for CVX? You can find out in our latest intrinsic value infographic research report.

Is Chevron Using Its Retained Earnings Effectively?

Chevron has a three-year median payout ratio of 32% (where it is retaining 68% of its income) which is not too low or not too high. So it seems that Chevron is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Moreover, Chevron is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 47% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 16%, over the same period.

Summary

Overall, we are quite pleased with Chevron's performance. In particular, it's great to see that the company has seen significant growth in its earnings backed by a respectable ROE and a high reinvestment rate. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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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