African Rainbow Minerals Limited (JSE:ARI) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?

African Rainbow Minerals' (JSE:ARI) stock is up by a considerable 18% over the past three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Particularly, we will be paying attention to African Rainbow Minerals' ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for African Rainbow Minerals

How Do You Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for African Rainbow Minerals is:

8.1% = R4.4b ÷ R54b (Based on the trailing twelve months to December 2023).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every ZAR1 worth of equity, the company was able to earn ZAR0.08 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. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

African Rainbow Minerals' Earnings Growth And 8.1% ROE

As you can see, African Rainbow Minerals' ROE looks pretty weak. Not just that, even compared to the industry average of 12%, the company's ROE is entirely unremarkable. Although, we can see that African Rainbow Minerals saw a modest net income growth of 18% over the past five years. We reckon that there could 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.

As a next step, we compared African Rainbow Minerals' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 27% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 African Rainbow Minerals''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is African Rainbow Minerals Using Its Retained Earnings Effectively?

While African Rainbow Minerals has a three-year median payout ratio of 52% (which means it retains 48% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.

Moreover, African Rainbow Minerals 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. 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 58%. However, African Rainbow Minerals' ROE is predicted to rise to 14% despite there being no anticipated change in its payout ratio.

Summary

Overall, we have mixed feelings about African Rainbow Minerals. While no doubt its earnings growth is pretty respectable, the low profit retention could mean that the company's earnings growth could have been higher, had it been paying reinvesting a higher portion of its profits. An improvement in its ROE could also help future earnings growth. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. 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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com