Diamondback Energy's (NASDAQ:FANG) stock is up by a considerable 34% 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. Specifically, we decided to study Diamondback Energy'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

How To Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Diamondback Energy is:

19% = US$3.4b ÷ US$18b (Based on the trailing twelve months to March 2024).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every $1 worth of equity, the company was able to earn $0.19 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

Diamondback Energy's Earnings Growth And 19% ROE

To begin with, Diamondback Energy seems to have a respectable ROE. Even when compared to the industry average of 19% the company's ROE looks quite decent. This probably goes some way in explaining Diamondback Energy's significant 44% net income growth over the past five years amongst other factors. We reckon that there could also be other factors at play here. 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.

As a next step, we compared Diamondback Energy's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 37% in the same period.

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

Is Diamondback Energy Efficiently Re-investing Its Profits?

Diamondback Energy's three-year median payout ratio is a pretty moderate 37%, meaning the company retains 63% of its income. By the looks of it, the dividend is well covered and Diamondback Energy is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Moreover, Diamondback Energy is determined to keep sharing its profits with shareholders which we infer from its long history of six years of paying a dividend. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 43%. Regardless, Diamondback Energy's ROE is speculated to decline to 12% despite there being no anticipated change in its payout ratio.

Conclusion

On the whole, we feel that Diamondback Energy'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. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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.