African Rainbow Minerals Limited (JSE:ARI) Stock Has Shown Weakness Lately But Financials Look Strong: Should Prospective Shareholders Make The Leap?
African Rainbow Minerals (JSE:ARI) has had a rough three months with its share price down 10%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study African Rainbow Minerals' ROE in this article.
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.
Check out our latest analysis for African Rainbow Minerals
How Is ROE Calculated?
The formula for ROE is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for African Rainbow Minerals is:
29% = R15b ÷ R52b (Based on the trailing twelve months to December 2022).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each ZAR1 of shareholders' capital it has, the company made ZAR0.29 in profit.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.
African Rainbow Minerals' Earnings Growth And 29% ROE
To begin with, African Rainbow Minerals seems to have a respectable ROE. Further, the company's ROE compares quite favorably to the industry average of 21%. This certainly adds some context to African Rainbow Minerals' exceptional 31% net income growth seen over the past five years. We reckon that there could also be other factors at play here. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
As a next step, we compared African Rainbow Minerals' net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 34% 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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about African Rainbow Minerals''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is African Rainbow Minerals Using Its Retained Earnings Effectively?
African Rainbow Minerals' significant three-year median payout ratio of 52% (where it is retaining only 48% of its income) suggests that the company has been able to achieve a high growth in earnings despite returning most of its income to shareholders.
Moreover, African Rainbow Minerals is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 49% of its profits over the next three years. Still, forecasts suggest that African Rainbow Minerals' future ROE will drop to 15% even though the the company's payout ratio is not expected to change by much.
Conclusion
On the whole, we feel that African Rainbow Minerals' performance has been quite good. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. That being so, according to the latest industry analyst forecasts, the company's earnings are expected 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.
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.
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