Valero Energy (NYSE:VLO) has had a rough three months with its share price down 13%. 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 Valero Energy's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Valero Energy

How Do You Calculate Return On Equity?

The formula for ROE is:

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. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.22 in profit.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

A Side By Side comparison of Valero Energy's Earnings Growth And 22% ROE

To begin with, Valero Energy seems to have a respectable ROE. On comparing with the average industry ROE of 16% the company's ROE looks pretty remarkable. Probably as a result of this, Valero Energy was able to see an impressive net income growth of 46% over the last 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.

Next, on comparing Valero Energy's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 40% over the last few years.

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is VLO fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Valero Energy Efficiently Re-investing Its Profits?

Valero Energy's three-year median payout ratio to shareholders is 16%, which is quite low. This implies that the company is retaining 84% of its profits. So it looks like Valero Energy is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Moreover, Valero Energy is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 40% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 12%, over the same period.

Conclusion

In total, we are pretty happy 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. 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 latest analysts predictions for the company, check out this visualization of analyst forecasts 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.