Anglo American's (LON:AAL) stock is up by a considerable 13% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. In this article, we decided to focus on Anglo American's ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for Anglo American

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 Anglo American is:

10% = US$3.3b ÷ US$33b (Based on the trailing twelve months to December 2020).

The 'return' is the amount earned after tax over the last twelve months. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.10 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 10% ROE

To begin with, Anglo American seems to have a respectable ROE. Yet, the fact that the company's ROE is lower than the industry average of 17% does temper our expectations. However, we are pleased to see the impressive 37% net income growth reported by Anglo American over the past five years. We reckon that there could be other factors at play here. Such as – high earnings retention or an efficient management in place. Bear in mind, the company does have a respectable ROE. It is just that the industry ROE is higher. So this also does lend some color to the high earnings growth seen by the company.

Next, on comparing with the industry net income growth, we found that Anglo American's growth is quite high when compared to the industry average growth of 27% in the same period, which is great to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Anglo American's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Anglo American Making Efficient Use Of Its Profits?

The three-year median payout ratio for Anglo American is 41%, which is moderately low. The company is retaining the remaining 59%. By the looks of it, the dividend is well covered and Anglo American is reinvesting its profits efficiently as evidenced by its exceptional growth which we discussed above.

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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 42% of its profits over the next three years. Regardless, the future ROE for Anglo American is predicted to rise to 13% despite there being not much change expected in its payout ratio.

Summary

On the whole, we feel that Anglo American's performance has been quite good. In particular, it's great to see that the company has seen significant growth in its earnings backed by a respectable ROE and a high reinvestment rate. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.

This article by Simply Wall St is general in nature. 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.

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