Has African Rainbow Minerals Limited's (JSE:ARI) Impressive Stock Performance Got Anything to Do With Its Fundamentals?

African Rainbow Minerals' (JSE:ARI) stock is up by a considerable 12% over the past three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Specifically, we decided to study African Rainbow Minerals' ROE in this article.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for African Rainbow Minerals

How Is ROE Calculated?

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:

29% = R14b ÷ R50b (Based on the trailing twelve months to June 2022).

The 'return' is the profit over the last twelve months. So, this means that for every ZAR1 of its shareholder's investments, the company generates a profit of ZAR0.29.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

A Side By Side comparison of African Rainbow Minerals' Earnings Growth And 29% ROE

To start with, African Rainbow Minerals' ROE looks acceptable. Further, the company's ROE is similar to the industry average of 27%. Consequently, this likely laid the ground for the impressive net income growth of 34% seen over the past five years by African Rainbow Minerals. However, there could also be other drivers behind this growth. 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 45% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. Has the market priced in the future outlook for ARI? You can find out in our latest intrinsic value infographic research report.

Is African Rainbow Minerals Using Its Retained Earnings Effectively?

African Rainbow Minerals' significant three-year median payout ratio of 53% (where it is retaining only 47% of its income) suggests that the company has been able to achieve a high growth in earnings despite returning most of its income to shareholders.

Besides, African Rainbow Minerals has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 47% of its profits over the next three years. However, African Rainbow Minerals' future ROE is expected to decline to 15% despite there being not much change anticipated in the company's payout ratio.

Conclusion

In total, it does look like African Rainbow Minerals has some positive aspects to its business. Its earnings have grown respectably as we saw earlier, which was likely due to the company reinvesting its earnings at a pretty high rate of return. However, given the high ROE, we do think that the company is reinvesting a small portion of its profits. This could likely be preventing the company from growing to its full extent. 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.