Rio Tinto Group (LON:RIO) has had a great run on the share market with its stock up by a significant 11% over the last 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 Rio Tinto Group's ROE in this article.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Do You 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 Rio Tinto Group is:
20% = US$10b ÷ US$52b (Based on the trailing twelve months to December 2020).
The 'return' refers to a company's earnings over the last year. That means that for every £1 worth of shareholders' equity, the company generated £0.20 in profit.
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.
Rio Tinto Group's Earnings Growth And 20% ROE
To start with, Rio Tinto Group's ROE looks acceptable. Further, the company's ROE is similar to the industry average of 17%. This probably goes some way in explaining Rio Tinto Group's significant 26% 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.
Next, on comparing Rio Tinto Group's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 26% in the same period.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. Is Rio Tinto Group fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Rio Tinto Group Making Efficient Use Of Its Profits?
The high three-year median payout ratio of 57% (implying that it keeps only 43% of profits) for Rio Tinto Group suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.
Additionally, Rio Tinto Group has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 51%. As a result, Rio Tinto Group's ROE is not expected to change by much either, which we inferred from the analyst estimate of 20% for future ROE.
On the whole, we feel that Rio Tinto Group's performance has been quite good. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. Having said that, on studying current analyst estimates, we were concerned to see that while the company has grown its earnings in the past, analysts expect its earnings to shrink in the future. 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. 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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