Is Weakness In Civitas Resources, Inc. (NYSE:CIVI) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

With its stock down 6.0% over the past week, it is easy to disregard Civitas Resources (NYSE:CIVI). 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 Civitas Resources' ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Civitas Resources

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 Civitas Resources is:

22% = US$1.1b ÷ US$5.3b (Based on the trailing twelve months to September 2022).

The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.22 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. 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.

Civitas Resources' Earnings Growth And 22% ROE

To start with, Civitas Resources' ROE looks acceptable. Even so, when compared with the average industry ROE of 31%, we aren't very excited. That being the case, the significant five-year 56% net income growth reported by Civitas Resources comes as a pleasant surprise. We believe that there might 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. Bear in mind, the company does have a respectable ROE. It is just that the industry ROE is higher. So this certainly also provides some context to the high earnings growth seen by the company.

As a next step, we compared Civitas Resources' net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 11%.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is CIVI fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Civitas Resources Using Its Retained Earnings Effectively?

Civitas Resources' three-year median payout ratio is a pretty moderate 27%, meaning the company retains 73% of its income. By the looks of it, the dividend is well covered and Civitas Resources is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Along with seeing a growth in earnings, Civitas Resources only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to rise to 72% over the next three years.

Summary

Overall, we are quite pleased with Civitas Resources' performance. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.

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