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Declining Stock and Decent Financials: Is The Market Wrong About Pilbara Minerals Limited (ASX:PLS)?

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With its stock down 18% over the past three months, it is easy to disregard Pilbara Minerals (ASX:PLS). 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. In this article, we decided to focus on Pilbara Minerals' ROE.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for Pilbara Minerals

How Is ROE Calculated?

Return on equity 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 Pilbara Minerals is:

10.0% = AU$84m ÷ AU$841m (Based on the trailing twelve months to December 2021).

The 'return' is the amount earned after tax over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.10 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. 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

Pilbara Minerals' Earnings Growth And 10.0% ROE

At first glance, Pilbara Minerals seems to have a decent ROE. Even so, when compared with the average industry ROE of 16%, we aren't very excited. Further, Pilbara Minerals' five year net income growth of 4.0% is on the lower side. Bear in mind, the company does have a respectable level of ROE. It is just that the industry ROE is higher. Hence there might be some other aspects that are keeping growth in earnings low. These include low earnings retention or poor capital allocation.

Next, on comparing with the industry net income growth, we found that Pilbara Minerals' reported growth was lower than the industry growth of 25% in the same period, which is not something we like to see.

past-earnings-growth
past-earnings-growth

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. If you're wondering about Pilbara Minerals''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Pilbara Minerals Using Its Retained Earnings Effectively?

Pilbara Minerals doesn't pay any dividend, which means that it is retaining all of its earnings. However, this doesn't explain the low earnings growth the company has seen. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Conclusion

In total, it does look like Pilbara Minerals has some positive aspects to its business. Yet, the low earnings growth is a bit concerning, especially given that the company has a respectable rate of return and is reinvesting a huge portion of its profits. By the looks of it, there could be some other factors, not necessarily in control of the business, that's preventing growth. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.