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Vital Energy Inc.'s (CVE:VUX) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

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Vital Energy's (CVE:VUX) stock is up by a considerable 75% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Specifically, we decided to study Vital Energy's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Vital Energy

How To Calculate Return On Equity?

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 Vital Energy is:

74% = CA$8.9m ÷ CA$12m (Based on the trailing twelve months to December 2021).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each CA$1 of shareholders' capital it has, the company made CA$0.74 in profit.

What Has ROE Got To Do With 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 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 Vital Energy's Earnings Growth And 74% ROE

First thing first, we like that Vital Energy has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 22% also doesn't go unnoticed by us. Despite this, Vital Energy's five year net income growth was quite low averaging at only 4.2%. This is interesting as the high returns should mean that the company has the ability to generate high growth but for some reason, it hasn't been able to do so. Such a scenario is likely to take place when a company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

As a next step, we compared Vital Energy's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 14% in the same period.

past-earnings-growth
past-earnings-growth

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Vital Energy is trading on a high P/E or a low P/E, relative to its industry.

Is Vital Energy Efficiently Re-investing Its Profits?

Vital Energy doesn't pay any dividend, which means that it is retaining all of its earnings. This doesn't explain the low earnings growth number that we discussed above. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Conclusion

On the whole, we do feel that Vital Energy has some positive attributes. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return and is reinvesting ma huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 3 risks we have identified for Vital Energy by visiting our risks dashboard for free on our platform here.

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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