Oil and Natural Gas (NSE: ONGC) has had a strong run in the equity market with a significant increase in its share of 37% in the past three months. But the company’s key financial metrics appear to differ across the board, leading us to question whether the current momentum in the company’s stock price can be sustained. In particular, we will pay special attention to the ROE of oil and natural gas today.
Return on equity or ROE is a key metric used to assess the efficiency with which the management of a business is using business capital. In other words, it is a profitability ratio that measures the rate of return on capital contributed by the shareholders of the company.
Check out our latest analysis for oil and natural gas
How do you calculate return on equity?
Return on equity can be calculated using the formula:
Return on equity = Net income (from continuing operations) ÷ Equity
So, based on the above formula, the ROE for oil and natural gas is:
11% = ₹ 271b ÷ ₹ 2.4t (Based on the last twelve months up to June 2021).
The “return” is the profit of the last twelve months. Another way to think about this is that for every 1 value of equity, the company was able to make 0.11 profit.
What does ROE have to do with profit growth?
We have already established that ROE is an effective indicator of profit generation for a company’s future profits. Based on the portion of its profits that the company chooses to reinvest or “keep”, we are then able to assess a company’s future ability to generate profits. Generally speaking, all other things being equal, companies with high return on equity and high profit retention have a higher growth rate than companies that do not share these attributes.
Growth in oil and gas profits and 11% ROE
At first glance, the ROE for oil and natural gas does not look very promising. Still, further study shows that the company’s ROE is similar to the industry average of 13%. That said, the rate of decline in five-year net income for oil and natural gas was 25%. Keep in mind that the business has a slightly low ROE. So that’s what could cause earnings growth to contract.
So, in the next step, we compared the performance of oil and natural gas to that of the industry and were disappointed to find that as the company reduced its profits, the industry increased its profits to a rate of 3.9% over the same period. .
The basis for attaching value to a business is, to a large extent, related to the growth of its profits. The investor should try to establish whether the expected growth or decline in earnings, as the case may be, is taken into account. This will help him determine if the future of the stock looks bright or worrisome. Is the CGSB valued enough? This intrinsic business value infographic has everything you need to know.
Are oil and natural gas making efficient use of their profits?
Looking at its three-year median payout rate of 44% (or a retention rate of 56%), which is pretty normal, the decline in oil and gas profits is rather disconcerting as one would expect to see good growth when a company keeps a good portion of its profits. So there could be other factors at play here that could potentially hamper growth. For example, the company faced headwinds.
In addition, oil and natural gas have paid dividends over a period of at least ten years, which means that the management of the company is committed to paying dividends even if it means little to no growth in earnings. Our latest analyst data shows the company’s future payout ratio is expected to drop to 34% over the next three years. Either way, the ROE is not expected to change much for the company despite the expected lower payout ratio.
All in all, we are a little ambivalent about the performance of oil and natural gas. Even though it appears to be keeping most of its earnings, given the low ROE, investors might not benefit from all this reinvestment after all. The weak earnings growth suggests that our theory is correct. That said, looking at current analysts’ estimates, we found that the company’s earnings growth rate is expected to see a huge improvement. Are the expectations of these analysts based on general industry expectations or on company fundamentals? Click here to go to our business analyst forecasts page.
This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell shares and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in the mentioned stocks.
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