Are Strong Financial Prospects The Force That Is Driving The Momentum In Champion Iron Limited's ASX:CIA) Stock?

Champion Iron's (ASX:CIA) stock is up by a considerable 6.6% over the past month. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. In this article, we decided to focus on Champion Iron's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Champion Iron

How To 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 Champion Iron is:

14% = CA$176m ÷ CA$1.2b (Based on the trailing twelve months to June 2023).

The 'return' refers to a company's earnings over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.14.

Why Is ROE Important For Earnings Growth?

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

Champion Iron's Earnings Growth And 14% ROE

To begin with, Champion Iron seems to have a respectable ROE. Especially when compared to the industry average of 10% the company's ROE looks pretty impressive. This probably laid the ground for Champion Iron's significant 32% net income growth seen over the past five years. We reckon that there could also be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

Next, on comparing with the industry net income growth, we found that Champion Iron's growth is quite high when compared to the industry average growth of 25% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Champion Iron's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Champion Iron Using Its Retained Earnings Effectively?

The three-year median payout ratio for Champion Iron is 36%, which is moderately low. The company is retaining the remaining 64%. By the looks of it, the dividend is well covered and Champion Iron is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

Along with seeing a growth in earnings, Champion Iron only recently started paying dividends. Its quite possible that the company was looking to impress 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 38%. Still, forecasts suggest that Champion Iron's future ROE will rise to 23% even though the the company's payout ratio is not expected to change by much.

Summary

In total, we are pretty happy with Champion Iron's performance. 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. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.