Shell plc (LON:SHEL) Stock Has Shown Weakness Lately But Financials Look Strong: Should Prospective Shareholders Make The Leap?

Simply Wall St · 10/25 10:59

With its stock down 8.5% over the past three months, it is easy to disregard Shell (LON:SHEL). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study Shell's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Shell

How Do You 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 Shell is:

10% = US$19b ÷ US$187b (Based on the trailing twelve months to June 2024).

The 'return' is the income the business earned over the last year. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.10.

What Has ROE Got To Do With 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.

A Side By Side comparison of Shell's Earnings Growth And 10% ROE

To start with, Shell's ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 8.7%. Consequently, this likely laid the ground for the impressive net income growth of 28% seen over the past five years by Shell. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

We then performed a comparison between Shell's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 26% in the same 5-year period.

past-earnings-growth
LSE:SHEL Past Earnings Growth October 25th 2024

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. Doing so will help them establish if the stock's future looks promising or ominous. Is SHEL fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Shell Efficiently Re-investing Its Profits?

Shell has a three-year median payout ratio of 35% (where it is retaining 65% of its income) which is not too low or not too high. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Shell is reinvesting its earnings efficiently.

Additionally, Shell 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 39% of its profits over the next three years. As a result, Shell's ROE is not expected to change by much either, which we inferred from the analyst estimate of 11% for future ROE.

Conclusion

On the whole, we feel that Shell's performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.