With its stock down 6.7% over the past month, it is easy to disregard Chesapeake Energy (NASDAQ:CHK). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Chesapeake Energy's ROE in this article.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

How Is ROE Calculated?

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 Chesapeake Energy is:

9.9% = US$1.1b ÷ US$11b (Based on the trailing twelve months to March 2024).

The 'return' is the profit over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.10.

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. 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.

Chesapeake Energy's Earnings Growth And 9.9% ROE

When you first look at it, Chesapeake Energy's ROE doesn't look that attractive. Next, when compared to the average industry ROE of 18%, the company's ROE leaves us feeling even less enthusiastic. However, we we're pleasantly surprised to see that Chesapeake Energy grew its net income at a significant rate of 43% in the last five years. So, there might be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

We then performed a comparison between Chesapeake Energy's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 38% in the same 5-year period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Chesapeake Energy is trading on a high P/E or a low P/E, relative to its industry.

Is Chesapeake Energy Making Efficient Use Of Its Profits?

Chesapeake Energy's three-year median payout ratio to shareholders is 17%, which is quite low. This implies that the company is retaining 83% of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Besides, Chesapeake Energy has been paying dividends over a period of three years. This shows that the company is committed to sharing profits with its shareholders. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 53% over the next three years. Despite the higher expected payout ratio, the company's ROE is not expected to change by much.

Conclusion

In total, it does look like Chesapeake Energy has some positive aspects to its business. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com