Chesapeake Energy (NASDAQ:CHK) has had a rough three months with its share price down 17%. However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Chesapeake Energy's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

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:

44% = US$2.8b ÷ US$6.3b (Based on the trailing twelve months to September 2022).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.44 in profit.

Why Is ROE Important For 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.

Chesapeake Energy's Earnings Growth And 44% ROE

To begin with, Chesapeake Energy has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 33% which is quite remarkable. This probably laid the groundwork for Chesapeake Energy's moderate 16% net income growth seen over the past five years.

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 7.4% in the same period.

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Chesapeake Energy's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Chesapeake Energy Making Efficient Use Of Its Profits?

Chesapeake Energy's three-year median payout ratio to shareholders is 1.3% (implying that it retains 99% of its income), which is on the lower side, so it seems like the management is reinvesting profits heavily to grow its business.

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. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 77% over the next three years. Consequently, the higher expected payout ratio explains the decline in the company's expected ROE (to 31%) over the same period.

Summary

Overall, we are quite pleased with Chesapeake Energy's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. 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 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.