Saudi Arabian Oil (TADAWUL:2222) has had a rough month with its share price down 5.1%. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Particularly, we will be paying attention to Saudi Arabian Oil'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Saudi Arabian Oil

How Is ROE Calculated?

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 Saudi Arabian Oil is:

29% = ر.س507b ÷ ر.س1.7t (Based on the trailing twelve months to June 2023).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every SAR1 worth of equity, the company was able to earn SAR0.29 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

Saudi Arabian Oil's Earnings Growth And 29% ROE

Firstly, we acknowledge that Saudi Arabian Oil has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 13% also doesn't go unnoticed by us. Probably as a result of this, Saudi Arabian Oil was able to see a decent net income growth of 14% over the last five years.

Next, on comparing with the industry net income growth, we found that Saudi Arabian Oil's reported growth was lower than the industry growth of 21% over the last few years, which is not something we like to see.

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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Saudi Arabian Oil's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Saudi Arabian Oil Making Efficient Use Of Its Profits?

While Saudi Arabian Oil has a three-year median payout ratio of 64% (which means it retains 36% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.

Moreover, Saudi Arabian Oil is determined to keep sharing its profits with shareholders which we infer from its long history of four years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 83% over the next three years. Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.

Summary

Overall, we feel that Saudi Arabian Oil certainly does have some positive factors to consider. Its earnings growth is decent, and the high ROE does contribute to that growth. However, investors could have benefitted even more from the high ROE, had the company been reinvesting more of its earnings. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings 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.

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.