Is Weakness In Chesapeake Energy Corporation (NASDAQ:CHK) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?
Chesapeake Energy (NASDAQ:CHK) has had a rough three months with its share price down 20%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Chesapeake Energy's ROE today.
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.
See our latest analysis for Chesapeake Energy
How To Calculate Return On Equity?
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:
54% = US$4.9b ÷ US$9.1b (Based on the trailing twelve months to December 2022).
The 'return' is the yearly profit. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.54.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.
Chesapeake Energy's Earnings Growth And 54% ROE
Firstly, we acknowledge that Chesapeake Energy has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 30% which is quite remarkable. So, the substantial 24% net income growth seen by Chesapeake Energy over the past five years isn't overly surprising.
We then compared Chesapeake Energy's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 16% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Is CHK fairly valued? This infographic on the company's intrinsic value has everything you need to know.
Is Chesapeake Energy Making Efficient Use Of Its Profits?
Chesapeake Energy has a really low three-year median payout ratio of 1.6%, meaning that it has the remaining 98% left over to reinvest into its business. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.
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 30% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 16% over the same period.
Overall, we are quite pleased with Chesapeake Energy's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. 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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