Rio Tinto Group's's (LON:RIO) stock is up by a considerable 28% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. Particularly, we will be paying attention to Rio Tinto Group's ROE today.
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.
How To 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 Rio Tinto Group is:
15% = US$7.0b ÷ US$45b (Based on the trailing twelve months to December 2019).
The 'return' is the profit over the last twelve months. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.15.
Why Is ROE Important For Earnings Growth?
Thus far, we have learnt 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. 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.
Rio Tinto Group's Earnings Growth And 15% ROE
To start with, Rio Tinto Group's ROE looks acceptable. Further, the company's ROE is similar to the industry average of 15%. This certainly adds some context to Rio Tinto Group's exceptional 35% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.
We then performed a comparison between Rio Tinto Group's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 34% in the same period.
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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Rio Tinto Group fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is Rio Tinto Group Efficiently Re-investing Its Profits?
The high three-year median payout ratio of 57% (implying that it keeps only 43% of profits) for Rio Tinto Group suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.
Moreover, Rio Tinto 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 65% of its profits over the next three years. As a result, Rio Tinto Group's ROE is not expected to change by much either, which we inferred from the analyst estimate of 15% for future ROE.
On the whole, we feel that Rio Tinto Group's performance has been quite good. We are particularly impressed by the considerable earnings growth posted by the company, which was likely backed by its high ROE. While the company is paying out most of its earnings as dividends, it has been able to grow its earnings in spite of it, so that's probably a good sign. 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 company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.
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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