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Fortescue Metals Group Limited's (ASX:FMG) Stock's On An Uptrend: Are Strong Financials Guiding The Market?

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·4 min read
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Fortescue Metals Group (ASX:FMG) has had a great run on the share market with its stock up by a significant 12% over the last month. 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 Fortescue Metals Group'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Fortescue Metals Group

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 Fortescue Metals Group is:

42% = US$6.4b ÷ US$15b (Based on the trailing twelve months to December 2020).

The 'return' is the yearly profit. That means that for every A$1 worth of shareholders' equity, the company generated A$0.42 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.

Fortescue Metals Group's Earnings Growth And 42% ROE

Firstly, we acknowledge that Fortescue Metals Group has a significantly high ROE. Secondly, even when compared to the industry average of 15% the company's ROE is quite impressive. Under the circumstances, Fortescue Metals Group's considerable five year net income growth of 40% was to be expected.

Next, on comparing with the industry net income growth, we found that Fortescue Metals Group's growth is quite high when compared to the industry average growth of 28% in the same period, which is great to see.

past-earnings-growth
past-earnings-growth

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. This then helps them determine if the stock is placed for a bright or bleak future. Is Fortescue Metals Group fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Fortescue Metals Group Efficiently Re-investing Its Profits?

Fortescue Metals Group has a significant three-year median payout ratio of 60%, meaning the company only retains 40% of its income. This implies that the company has been able to achieve high earnings growth despite returning most of its profits to shareholders.

Moreover, Fortescue Metals Group 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. Looking at the current analyst consensus data, we can see that the company's future payout ratio is expected to rise to 77% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 19% over the same period.

Summary

Overall, we are quite pleased with Fortescue Metals Group's performance. 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. 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. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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