Declining Stock and Decent Financials: Is The Market Wrong About Kumba Iron Ore Limited (JSE:KIO)?

With its stock down 10% over the past three months, it is easy to disregard Kumba Iron Ore (JSE:KIO). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study Kumba Iron Ore'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.

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How To 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 Kumba Iron Ore is:

28% = R19b ÷ R69b (Based on the trailing twelve months to December 2024).

The 'return' is the yearly profit. So, this means that for every ZAR1 of its shareholder's investments, the company generates a profit of ZAR0.28.

Check out our latest analysis for Kumba Iron Ore

Why Is ROE Important For 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. 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.

Kumba Iron Ore's Earnings Growth And 28% ROE

To start with, Kumba Iron Ore's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 11%. As you might expect, the 5.0% net income decline reported by Kumba Iron Ore is a bit of a surprise. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. For example, it could be that the company has a high payout ratio or the business has allocated capital poorly, for instance.

So, as a next step, we compared Kumba Iron Ore's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 11% over the last few years.

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for KIO? You can find out in our latest intrinsic value infographic research report.

Is Kumba Iron Ore Using Its Retained Earnings Effectively?

Kumba Iron Ore's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 89% (or a retention ratio of 11%). With only a little being reinvested into the business, earnings growth would obviously be low or non-existent. You can see the 3 risks we have identified for Kumba Iron Ore by visiting our risks dashboard for free on our platform here.

Moreover, Kumba Iron Ore has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 75% of its profits over the next three years. Regardless, Kumba Iron Ore's ROE is speculated to decline to 22% despite there being no anticipated change in its payout ratio.

Conclusion

In total, it does look like Kumba Iron Ore has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. Additionally, the latest industry analyst forecasts show that the company is expected to continue to see a similar decline in its earnings in the future as well. 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.