CNOOC (HKG:883) has had a rough three months with its share price down 7.4%. However, stock prices are usually driven by a company's financial performance over the long term, which in this case looks quite promising. In this article, we decided to focus on CNOOC'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How Is ROE Calculated?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for CNOOC is:

20% = CN¥143b ÷ CN¥721b (Based on the trailing twelve months to September 2024).

The 'return' refers to a company's earnings over the last year. That means that for every HK$1 worth of shareholders' equity, the company generated HK$0.20 in profit.

What Has ROE Got To Do With 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. 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.

CNOOC's Earnings Growth And 20% ROE

To start with, CNOOC's ROE looks acceptable. On comparing with the average industry ROE of 9.9% the company's ROE looks pretty remarkable. This probably laid the ground for CNOOC's significant 27% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing CNOOC's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 26% over the last few years.

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. This then helps them determine if the stock is placed for a bright or bleak future. Is CNOOC fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is CNOOC Using Its Retained Earnings Effectively?

The three-year median payout ratio for CNOOC is 42%, which is moderately low. The company is retaining the remaining 58%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like CNOOC is reinvesting its earnings efficiently.

Additionally, CNOOC has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 43%. Still, forecasts suggest that CNOOC's future ROE will drop to 15% even though the the company's payout ratio is not expected to change by much.

Conclusion

Overall, we are quite pleased with CNOOC'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 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.