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With its stock down 5.8% over the past three months, it is easy to disregard Fortescue (ASX:FMG). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Fortescue'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
View our latest analysis for Fortescue
How Do You 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 Fortescue is:
30% = US$5.8b ÷ US$19b (Based on the trailing twelve months to December 2023).
The 'return' refers to a company's earnings over the last year. That means that for every A$1 worth of shareholders' equity, the company generated A$0.30 in profit.
What Has ROE Got To Do With 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.
Fortescue's Earnings Growth And 30% ROE
First thing first, we like that Fortescue has an impressive ROE. Additionally, the company's ROE is higher compared to the industry average of 10% which is quite remarkable. This likely paved the way for the modest 12% net income growth seen by Fortescue over the past five years.
We then compared Fortescue's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 21% in the same 5-year period, which is a bit concerning.
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 FMG worth today? The intrinsic value infographic in our free research report helps visualize whether FMG is currently mispriced by the market.