Rio Tinto Group (LON:RIO) has had a rough three months with its share price down 19%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Rio Tinto Group's ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How To Calculate Return On Equity?
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 Rio Tinto Group is:
25% = US$13b ÷ US$52b (Based on the trailing twelve months to December 2022).
The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.25 in profit.
What Is The Relationship Between ROE And 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. 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 25% ROE
First thing first, we like that Rio Tinto Group has an impressive ROE. Additionally, the company's ROE is higher compared to the industry average of 13% which is quite remarkable. This probably laid the groundwork for Rio Tinto Group's moderate 13% net income growth seen over the past five years.
We then compared Rio Tinto Group's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 17% in the same period, which is a bit concerning.
Earnings growth is an important metric to consider when valuing a stock. 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. 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?
While Rio Tinto Group has a three-year median payout ratio of 64% (which means it retains 36% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.
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 57%. However, Rio Tinto Group's future ROE is expected to decline to 18% despite there being not much change anticipated in the company's payout ratio.
In total, it does look like Rio Tinto Group has some positive aspects to its business. Its earnings growth is decent, and the high ROE does contribute to that growth. However, investors could have benefitted even more from the high ROE, had the company been reinvesting more of its earnings. 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.
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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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