Is Weakness In Anglo American plc (LON:AAL) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

With its stock down 30% over the past three months, it is easy to disregard Anglo American (LON:AAL). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Anglo American's ROE today.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Anglo American

How To Calculate Return On Equity?

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 Anglo American is:

18% = US$6.0b ÷ US$34b (Based on the trailing twelve months to December 2022).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.18 in profit.

What Has ROE Got To Do With 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. 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.

Anglo American's Earnings Growth And 18% ROE

At first glance, Anglo American seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 13%. This certainly adds some context to Anglo American's decent 19% net income growth seen over the past five years.

Next, on comparing Anglo American's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 19% in the same period.

Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. What is AAL worth today? The intrinsic value infographic in our free research report helps visualize whether AAL is currently mispriced by the market.

Is Anglo American Using Its Retained Earnings Effectively?

Anglo American has a healthy combination of a moderate three-year median payout ratio of 44% (or a retention ratio of 56%) and a respectable amount of growth in earnings as we saw above, meaning that the company has been making efficient use of its profits.

Moreover, Anglo American 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 42%. Still, forecasts suggest that Anglo American's future ROE will drop to 13% even though the the company's payout ratio is not expected to change by much.

Summary

Overall, we are quite pleased with Anglo American'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. 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.