Valero Energy’s (NYSE:VLO) stock is up by a considerable 19% over the past three months. We, however wanted to have a closer look at its key financial indicators as the markets usually pay for long-term fundamentals, and in this case, they don’t look very promising. In this article, we decided to focus on Valero Energy’s ROE.
ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder’s equity.
See our latest analysis for Valero Energy
How To Calculate Return On Equity?
Return on equity 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 Valero Energy is:
6.5% = US$1.3b ÷ US$20b (Based on the trailing twelve months to December 2021).
The ‘return’ is the income the business earned over the last year. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.06 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or “retains” for future growth which then gives us an idea about the growth potential of the company. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Valero Energy’s Earnings Growth And 6.5% ROE
On the face of it, Valero Energy’s ROE is not much to talk about. A quick further study shows that the company’s ROE doesn’t compare favorably to the industry average of 16% either. Given the circumstances, the significant decline in net income by 39% seen by Valero Energy over the last five years is not surprising. We reckon that there could also be other factors at play here. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.
Furthermore, even when compared to the industry, which has been shrinking its earnings at a rate 10% in the same period, we found that Valero Energy’s performance is pretty disappointing, as it suggests that the company has been shrunk its earnings at a rate faster than the industry.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is VLO worth today? The intrinsic value infographic in our free research report helps visualize whether VLO is currently mispriced by the market.
Is Valero Energy Making Efficient Use Of Its Profits?
Valero Energy has a high three-year median payout ratio of 50% (that is, it is retaining 50% of its profits). This suggests that the company is paying most of its profits as dividends to its shareholders. This goes some way in explaining why its earnings have been shrinking. The business is only left with a small pool of capital to reinvest – A vicious cycle that doesn’t benefit the company in the long-run.
Additionally, Valero Energy has paid dividends over a period of at least ten years, which means that the company’s management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts’ consensus data, we found that the company is expected to keep paying out approximately 54% of its profits over the next three years. Still, forecasts suggest that Valero Energy’s future ROE will rise to 17% even though the the company’s payout ratio is not expected to change by much.
Summary
On the whole, Valero Energy’s performance is quite a big let-down. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company’s earnings growth rate. 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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