Legacy Iron Ore Limited's (ASX:LCY) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?
With its stock down 11% over the past three months, it is easy to disregard Legacy Iron Ore (ASX:LCY). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Specifically, we decided to study Legacy Iron Ore's ROE in this article.
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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
See our latest analysis for Legacy Iron Ore
How Do You 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 Legacy Iron Ore is:
7.9% = AU$2.0m ÷ AU$25m (Based on the trailing twelve months to March 2023).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.08 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. 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.
A Side By Side comparison of Legacy Iron Ore's Earnings Growth And 7.9% ROE
When you first look at it, Legacy Iron Ore's ROE doesn't look that attractive. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 16%. However, we we're pleasantly surprised to see that Legacy Iron Ore grew its net income at a significant rate of 44% in the last five years. Therefore, there could be other reasons behind this growth. Such as - high earnings retention or an efficient management in place.
As a next step, we compared Legacy Iron Ore's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 29%.
Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Is Legacy Iron Ore fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Legacy Iron Ore Making Efficient Use Of Its Profits?
Given that Legacy Iron Ore doesn't pay any dividend to its shareholders, we infer that the company has been reinvesting all of its profits to grow its business.
Conclusion
On the whole, we do feel that Legacy Iron Ore has some positive attributes. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. You can see the 4 risks we have identified for Legacy Iron Ore by visiting our risks dashboard for free on our platform here.
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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