Most readers would already be aware that Anglo American's (LON:AAL) stock increased significantly by 17% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Particularly, we will be paying attention to Anglo American'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Do You 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$9.7b ÷ US$38b (Based on the trailing twelve months to June 2021).
The 'return' is the profit over the last twelve months. That means that for every £1 worth of shareholders' equity, the company generated £0.26 in profit.
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. 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.
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 17% which is quite remarkable. As a result, Anglo American's exceptional 23% net income growth seen over the past five years, doesn't come as a surprise.
Next, on comparing Anglo American's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 22% in the same period.
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. This then helps them determine if the stock is placed for a bright or bleak future. 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 Efficiently Re-investing Its Profits?
Anglo American's three-year median payout ratio is a pretty moderate 41%, meaning the company retains 59% of its income. 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. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 46%. Still, forecasts suggest that Anglo American's future ROE will drop to 13% even though the the company's payout ratio is not expected to change by much.
In total, we are pretty happy 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. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. 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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