Declining Stock and Solid Fundamentals: Is The Market Wrong About Valero Energy Corporation (NYSE:VLO)?

Simply Wall St · 10/17 11:23

With its stock down 8.6% over the past three months, it is easy to disregard Valero Energy (NYSE:VLO). 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 Valero Energy's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Valero 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 Valero Energy is:

22% = US$6.1b ÷ US$28b (Based on the trailing twelve months to June 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 $0.22.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

Valero Energy's Earnings Growth And 22% ROE

To start with, Valero Energy's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 16%. This certainly adds some context to Valero Energy's exceptional 46% 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. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Valero Energy's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 40% in the same period.

past-earnings-growth
NYSE:VLO Past Earnings Growth October 17th 2024

Earnings growth is an important metric to consider when valuing a stock. 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. 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 Using Its Retained Earnings Effectively?

Valero Energy's ' three-year median payout ratio is on the lower side at 16% implying that it is retaining a higher percentage (84%) of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.

Besides, Valero Energy has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 44% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 12% over the same period.

Conclusion

Overall, we are quite pleased with Valero 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. That being so, according to the latest industry analyst forecasts, the company's earnings are expected to shrink in the future. 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.