Most readers would already be aware that Anglo American’s (LON:AAL) stock increased significantly by 19% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. In this article, we decided to focus on Anglo American’s ROE.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Anglo American

How To Calculate Return On Equity?

ROE 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 Anglo American is:

26% = US$9.3b ÷ US$36b (Based on the trailing twelve months to June 2022).

The ‘return’ is the yearly profit. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.26 in profit.

Why Is ROE Important For 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.

Anglo American’s Earnings Growth And 26% ROE

To begin with, Anglo American has a pretty high ROE which is interesting. Additionally, the company’s ROE is higher compared to the industry average of 13% which is quite remarkable. This probably laid the groundwork for Anglo American’s moderate 19% net income growth seen over the past five years.

We then performed a comparison between Anglo American’s net income growth with the industry, which revealed that the company’s growth is similar to the average industry growth of 18% in the same period.

past-earnings-growth

Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company’s expected earnings growth (or decline). Doing so will help them establish if the stock’s future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Anglo American is trading on a high P/E or a low P/E, relative to its industry.

Is Anglo American Using Its Retained Earnings Effectively?

With a three-year median payout ratio of 42% (implying that the company retains 58% of its profits), it seems that Anglo American is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that’s well covered.

Additionally, Anglo American has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 47%. However, Anglo American’s future ROE is expected to decline to 12% despite there being not much change anticipated in the company’s payout ratio.

Summary

Overall, we are quite pleased with Anglo American’s performance. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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. 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.

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

Join A Paid User Research SessionYou’ll receive a US$30 Amazon Gift card for 1 hour of your time while helping us build better investing tools for the individual investors like yourself. Sign up here