Shell (LON:SHEL) has had a rough month with its share price down 2.7%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Shell's ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Shell

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 Shell is:

9.2% = US$17b ÷ US$180b (Based on the trailing twelve months to December 2024).

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 £0.09.

Why Is ROE Important For 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.

A Side By Side comparison of Shell's Earnings Growth And 9.2% ROE

At first glance, Shell's ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 9.2%, we may spare it some thought. Moreover, we are quite pleased to see that Shell's net income grew significantly at a rate of 31% over the last five years. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this 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.

We then compared Shell's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 23% in the same 5-year period.

Earnings growth is an important metric to consider when valuing a stock. 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. What is SHEL worth today? The intrinsic value infographic in our free research report helps visualize whether SHEL is currently mispriced by the market.

Is Shell Efficiently Re-investing Its Profits?

Shell has a three-year median payout ratio of 35% (where it is retaining 65% of its income) which is not too low or not too high. By the looks of it, the dividend is well covered and Shell is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Besides, Shell has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 37%. However, Shell's ROE is predicted to rise to 12% despite there being no anticipated change in its payout ratio.

Conclusion

Overall, we feel that Shell certainly does have some positive factors to consider. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.