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Chesapeake Energy Corporation's (NASDAQ:CHK) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

Chesapeake Energy (NASDAQ:CHK) has had a rough month with its share price down 11%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Particularly, we will be paying attention to Chesapeake Energy's ROE today.

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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Chesapeake Energy

How Is ROE Calculated?

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 Chesapeake Energy is:

27% = US$1.6b ÷ US$5.8b (Based on the trailing twelve months to June 2022).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.27.

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.

A Side By Side comparison of Chesapeake Energy's Earnings Growth And 27% ROE

Firstly, we acknowledge that Chesapeake Energy has a significantly high ROE. Additionally, a comparison with the average industry ROE of 26% also portrays the company's ROE in a good light. So, Chesapeake Energy's moderate 11% growth over the past five years was probably backed by the high ROE.

Next, on comparing with the industry net income growth, we found that the growth figure reported by Chesapeake Energy compares quite favourably to the industry average, which shows a decline of 3.4% in the same period.

past-earnings-growth
past-earnings-growth

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. Is Chesapeake Energy fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Chesapeake Energy Efficiently Re-investing Its Profits?

Chesapeake Energy has a low three-year median payout ratio of 1.0%, meaning that the company retains the remaining 99% of its profits. This suggests that the management is reinvesting most of the profits to grow the business.

While Chesapeake Energy has been growing its earnings, it only recently started to pay dividends which likely means that the company decided to impress new and existing shareholders with a dividend. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 34% over the next three years. Still, forecasts suggest that Chesapeake Energy's future ROE will rise to 47% even though the the company's payout ratio is expected to rise. We presume that there could some other characteristics of the business that could be driving the anticipated growth in the company's ROE.

Conclusion

Overall, we are quite pleased with Chesapeake Energy's 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. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.

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

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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