With its stock down 23% over the past three months, it is easy to disregard Anglo American (LON:AAL). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Particularly, we will be paying attention to Anglo American'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.

Check out our latest analysis for Anglo American

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 Anglo American is:

34% = US$12b ÷ US$35b (Based on the trailing twelve months to December 2021).

The 'return' is the yearly profit. So, this means that for every £1 of its shareholder's investments, the company generates a profit of £0.34.

Why Is ROE Important For Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

Anglo American's Earnings Growth And 34% ROE

To begin with, Anglo American has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 14% also doesn't go unnoticed by us. This likely paved the way for the modest 18% net income growth seen by Anglo American over the past five years. growth

As a next step, we compared Anglo American'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 18% in the same period.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). Doing so will help them establish if the stock's future looks promising or ominous. Is AAL fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is Anglo American Efficiently Re-investing Its Profits?

With a three-year median payout ratio of 42% (implying that the company retains 58% of its profits), it seems that Anglo American is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.