Kumba Iron Ore Limited's (JSE:KIO) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

Kumba Iron Ore's (JSE:KIO) stock is up by a considerable 7.1% over the past month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Kumba Iron Ore's ROE today.

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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Kumba Iron Ore

How Do You Calculate Return On Equity?

Return on equity 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 Kumba Iron Ore is:

28% = R17b ÷ R61b (Based on the trailing twelve months to June 2023).

The 'return' is the income the business earned over the last year. So, this means that for every ZAR1 of its shareholder's investments, the company generates a profit of ZAR0.28.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Kumba Iron Ore's Earnings Growth And 28% ROE

To begin with, Kumba Iron Ore seems to have a respectable ROE. On comparing with the average industry ROE of 14% the company's ROE looks pretty remarkable. Probably as a result of this, Kumba Iron Ore was able to see a decent growth of 11% over the last five years.

Next, on comparing with the industry net income growth, we found that Kumba Iron Ore's reported growth was lower than the industry growth of 38% over the last few years, which is not something we like to see.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is KIO worth today? The intrinsic value infographic in our free research report helps visualize whether KIO is currently mispriced by the market.

Is Kumba Iron Ore Using Its Retained Earnings Effectively?

The high three-year median payout ratio of 95% (or a retention ratio of 4.8%) for Kumba Iron Ore suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Besides, Kumba Iron Ore 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's future payout ratio is expected to drop to 60% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.

Conclusion

On the whole, we do feel that Kumba Iron Ore has some positive attributes. Its earnings have grown respectably as we saw earlier, probably due to its high returns. However, it does reinvest little to almost none of its profits, so we wonder what effect this could have on its future growth prospects. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.