Kumba Iron Ore Limited's (JSE:KIO) Stock Is Going Strong: Have Financials A Role To Play?

Kumba Iron Ore (JSE:KIO) has had a great run on the share market with its stock up by a significant 24% over the last three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. In this article, we decided to focus on Kumba Iron Ore's ROE.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for Kumba Iron Ore

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 Kumba Iron Ore is:

46% = R28b ÷ R61b (Based on the trailing twelve months to June 2022).

The 'return' is the profit over the last twelve months. That means that for every ZAR1 worth of shareholders' equity, the company generated ZAR0.46 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. 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.

Kumba Iron Ore's Earnings Growth And 46% ROE

To begin with, Kumba Iron Ore has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 27% the company's ROE is quite impressive. So, the substantial 25% net income growth seen by Kumba Iron Ore over the past five years isn't overly surprising.

Next, on comparing with the industry net income growth, we found that Kumba Iron Ore's reported growth was lower than the industry growth of 45% in the same period, which is not something we like to see.

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 KIO fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Kumba Iron Ore Making Efficient Use Of Its Profits?

Kumba Iron Ore's significant three-year median payout ratio of 91% (where it is retaining only 9.5% of its income) suggests that the company has been able to achieve a high growth in earnings despite returning most of its income to shareholders.

Moreover, Kumba Iron Ore 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. Our latest analyst data shows that the future payout ratio of the company over the next three years is expected to be approximately 84%. However, Kumba Iron Ore's future ROE is expected to decline to 27% despite there being not much change anticipated in the company's payout ratio.

Conclusion

In total, it does look like Kumba Iron Ore has some positive aspects to its business. Its earnings have grown respectably as we saw earlier, probably due to its high returns. However, it does reinvest little to almost none of its profits, so we wonder what effect this could have on its future growth prospects. 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 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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