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Rio Tinto Group's (LON:RIO) Stock Has Been Sliding But Fundamentals Look Strong: Is The Market Wrong?

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Rio Tinto Group (LON:RIO) has had a rough three months with its share price down 14%. 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. Particularly, we will be paying attention to Rio Tinto Group's ROE today.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Rio Tinto Group

How To Calculate Return On Equity?

ROE 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 Rio Tinto Group is:

40% = US$23b ÷ US$57b (Based on the trailing twelve months to December 2021).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.40 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

Rio Tinto Group's Earnings Growth And 40% ROE

To begin with, Rio Tinto Group has a pretty high ROE which is interesting. Additionally, the company's ROE is higher compared to the industry average of 18% which is quite remarkable. Probably as a result of this, Rio Tinto Group was able to see a decent net income growth of 19% over the last five years.

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 19% in the same period.

past-earnings-growth
past-earnings-growth

Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. What is RIO worth today? The intrinsic value infographic in our free research report helps visualize whether RIO is currently mispriced by the market.

Is Rio Tinto Group Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 60% (or a retention ratio of 40%) for Rio Tinto Group suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Additionally, Rio Tinto Group has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 66%. Regardless, Rio Tinto Group's ROE is speculated to decline to 18% despite there being no anticipated change in its payout ratio.

Conclusion

On the whole, we feel that Rio Tinto Group's performance has been quite good. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. 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.

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.