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South32 (ASX:S32) has had a great run on the share market with its stock up by a significant 6.0% over the last week. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Particularly, we will be paying attention to South32's ROE today.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.
View our latest analysis for South32
How To 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 South32 is:
22% = US$2.3b ÷ US$11b (Based on the trailing twelve months to December 2022).
The 'return' is the income the business earned over the last year. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.22.
What Is The Relationship Between ROE And Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. 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 everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.
South32's Earnings Growth And 22% ROE
To begin with, South32 has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 17% the company's ROE is quite impressive. This probably laid the groundwork for South32's moderate 19% net income growth seen over the past five years.
Next, on comparing with the industry net income growth, we found that South32's reported growth was lower than the industry growth of 29% in the same period, which is not something we like to see.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. What is S32 worth today? The intrinsic value infographic in our free research report helps visualize whether S32 is currently mispriced by the market.