Is Champion Iron Limited's (ASX:CIA) Latest Stock Performance A Reflection Of Its Financial Health?

Unlock stock picks and a broker-level newsfeed that powers Wall Street.

Simply Wall St

Thu, May 26, 2022, 6:48 PM 4 min read

Most readers would already be aware that Champion Iron's (ASX:CIA) stock increased significantly by 21% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Particularly, we will be paying attention to Champion Iron'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Champion Iron

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 Champion Iron is:

51% = CA$563m ÷ CA$1.1b (Based on the trailing twelve months to December 2021).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.51 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. 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.

A Side By Side comparison of Champion Iron's Earnings Growth And 51% ROE

First thing first, we like that Champion Iron has an impressive ROE. Second, a comparison with the average ROE reported by the industry of 16% also doesn't go unnoticed by us. As a result, Champion Iron's exceptional 73% net income growth seen over the past five years, doesn't come as a surprise.

Next, on comparing with the industry net income growth, we found that Champion Iron's growth is quite high when compared to the industry average growth of 26% in the same period, which is great to see.

past-earnings-growth — ASX:CIA Past Earnings Growth May 27th 2022

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is CIA worth today? The intrinsic value infographic in our free research report helps visualize whether CIA is currently mispriced by the market.

Is Champion Iron Efficiently Re-investing Its Profits?

Champion Iron's three-year median payout ratio to shareholders is 8.5%, which is quite low. This implies that the company is retaining 92% of its profits. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Our latest analyst data shows that the future payout ratio of the company is expected to rise to 47% over the next three years. Therefore, the expected rise in the payout ratio explains why the company's ROE is expected to decline to 23% over the same period.

Summary

In total, we are pretty happy with Champion Iron's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. 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. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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.