Most readers would already be aware that Chesapeake Energy's (NASDAQ:CHK) stock increased significantly by 11% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Chesapeake Energy's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How Do You Calculate Return On Equity?

Return on equity 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 Chesapeake Energy is:

23% = US$2.4b ÷ US$11b (Based on the trailing twelve months to December 2023).

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 $0.23.

What Is The Relationship Between ROE And 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.

Chesapeake Energy's Earnings Growth And 23% ROE

Firstly, we acknowledge that Chesapeake Energy has a significantly high ROE. Additionally, a comparison with the average industry ROE of 21% also portrays the company's ROE in a good light. Given the circumstances, the significant 44% net income growth seen by Chesapeake Energy over the last five years is not surprising.

As a next step, we compared Chesapeake Energy's 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 36%.

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 Chesapeake Energy fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Chesapeake Energy Making Efficient Use Of Its Profits?

Chesapeake Energy's ' three-year median payout ratio is on the lower side at 17% implying that it is retaining a higher percentage (83%) 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.

Additionally, Chesapeake Energy has paid dividends over a period of three years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 64% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 9.5%, over the same period.

Conclusion

In total, we are pretty happy with Chesapeake Energy's performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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.

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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.