Most readers would already be aware that Mount Gibson Iron's (ASX:MGX) stock increased significantly by 14% 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. Specifically, we decided to study Mount Gibson Iron's ROE in this article.
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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Do You 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 Mount Gibson Iron is:
16% = AU$114m ÷ AU$730m (Based on the trailing twelve months to December 2020).
The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.16 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
Mount Gibson Iron's Earnings Growth And 16% ROE
At first glance, Mount Gibson Iron seems to have a decent ROE. Further, the company's ROE is similar to the industry average of 15%. This certainly adds some context to Mount Gibson Iron's exceptional 22% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.
As a next step, we compared Mount Gibson Iron's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 28% in the same period.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Mount Gibson Iron's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Mount Gibson Iron Efficiently Re-investing Its Profits?
The three-year median payout ratio for Mount Gibson Iron is 34%, which is moderately low. The company is retaining the remaining 66%. So it seems that Mount Gibson Iron is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.
Moreover, Mount Gibson Iron is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company's future payout ratio is expected to drop to 25% over the next three years. As a result, the expected drop in Mount Gibson Iron's payout ratio explains the anticipated rise in the company's future ROE to 25%, over the same period.
In total, we are pretty happy with Mount Gibson Iron's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see a good amount of growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. Our risks dashboard would have the 4 risks we have identified for Mount Gibson Iron.
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This article by Simply Wall St is general in nature. 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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