Kumba Iron Ore Limited's (JSE:KIO) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

Kumba Iron Ore (JSE:KIO) has had a rough month with its share price down 11%. 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. Particularly, we will be paying attention to Kumba Iron Ore's 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.

Check out our latest analysis for Kumba Iron Ore

How Do You 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:

44% = R30b ÷ R68b (Based on the trailing twelve months to December 2023).

The 'return' refers to a company's earnings over the last year. So, this means that for every ZAR1 of its shareholder's investments, the company generates a profit of ZAR0.44.

What Has ROE Got To Do With 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.

Kumba Iron Ore's Earnings Growth And 44% ROE

To begin with, Kumba Iron Ore has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 13% also doesn't go unnoticed by us. This likely paved the way for the modest 5.4% net income growth seen by Kumba Iron Ore over the past five years.

As a next step, we compared Kumba Iron Ore's 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.

Earnings growth is a huge factor in stock valuation. 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. 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?

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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 72% over the next three years. Regardless, the future ROE for Kumba Iron Ore is predicted to decline to 26% despite the anticipated decrease in the payout ratio. We reckon that there could probably be other factors that could be driving the forseen decline in the company's ROE.

Conclusion

In total, it does look like Kumba Iron Ore has some positive aspects to its business. 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, 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. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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