Yahoo Finance Could The Market Be Wrong About Fortescue Metals Group Limited (ASX:FMG) Given Its Attractive Financial Prospects?
With its stock down 10% over the past month, it is easy to disregard Fortescue Metals Group (ASX:FMG). 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. In this article, we decided to focus on Fortescue Metals Group's ROE.
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.
Check out our latest analysis for Fortescue Metals Group
How To Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for Fortescue Metals Group is:
34% = US$5.8b ÷ US$17b (Based on the trailing twelve months to December 2022).
The 'return' is the income the business earned over the last year. That means that for every A$1 worth of shareholders' equity, the company generated A$0.34 in profit.
What Has ROE Got To Do With 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. 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.
Fortescue Metals Group's Earnings Growth And 34% ROE
Firstly, we acknowledge that Fortescue Metals Group has a significantly high ROE. Secondly, even when compared to the industry average of 16% the company's ROE is quite impressive. Under the circumstances, Fortescue Metals Group's considerable five year net income growth of 32% was to be expected.
As a next step, we compared Fortescue Metals Group's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 29% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Fortescue Metals Group is trading on a high P/E or a low P/E, relative to its industry.
Is Fortescue Metals Group Making Efficient Use Of Its Profits?
Fortescue Metals Group's significant three-year median payout ratio of 74% (where it is retaining only 26% 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, Fortescue Metals 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 67% of its profits over the next three years. Still, forecasts suggest that Fortescue Metals Group's future ROE will drop to 18% even though the the company's payout ratio is not expected to change by much.
Conclusion
Overall, we are quite pleased with Fortescue Metals Group's performance. 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. With that said, on studying the latest analyst forecasts, we found that while the company has seen growth in its past earnings, analysts expect its future earnings to shrink. 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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