Occidental Petroleum (NYSE:OXY) has had a rough three months with its share price down 8.9%. 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 Occidental Petroleum's ROE today.
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.
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 Occidental Petroleum is:
19% = US$5.4b ÷ US$29b (Based on the trailing twelve months to September 2023).
The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.19.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.
A Side By Side comparison of Occidental Petroleum's Earnings Growth And 19% ROE
To start with, Occidental Petroleum's ROE looks acceptable. Even so, when compared with the average industry ROE of 23%, we aren't very excited. Still, we can see that Occidental Petroleum has seen a remarkable net income growth of 27% over the past five years. We believe that there might be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place. However, not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So this certainly also provides some context to the high earnings growth seen by the company.
As a next step, we compared Occidental Petroleum's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 33% in the same period.
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. This then helps them determine if the stock is placed for a bright or bleak future. Is OXY fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Occidental Petroleum Efficiently Re-investing Its Profits?
Occidental Petroleum has a really low three-year median payout ratio of 2.3%, meaning that it has the remaining 98% left over to reinvest into its business. So it looks like Occidental Petroleum is reinvesting profits heavily to grow its business, which shows in its earnings growth.
Besides, Occidental Petroleum has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 16% over the next three years. However, the company's ROE is not expected to change by much despite the higher expected payout ratio.
In total, we are pretty happy with Occidental Petroleum's performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.