Most readers would already be aware that Aurelia Metals' (ASX:AMI) stock increased significantly by 7.7% over the past week. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Specifically, we decided to study Aurelia Metals' ROE in this article.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

View our latest analysis for Aurelia Metals

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Aurelia Metals is:

8.5% = AU$34m ÷ AU$395m (Based on the trailing twelve months to December 2020).

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$0.09.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 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.

A Side By Side comparison of Aurelia Metals' Earnings Growth And 8.5% ROE

When you first look at it, Aurelia Metals' ROE doesn't look that attractive. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 15% either. In spite of this, Aurelia Metals was able to grow its net income considerably, at a rate of 33% in the last five years. Therefore, there could be other reasons behind this growth. Such as – high earnings retention or an efficient management in place.

We then performed a comparison between Aurelia Metals' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 28% in the same period.

Earnings growth is a huge factor in stock valuation. 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. Is Aurelia Metals fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Aurelia Metals Making Efficient Use Of Its Profits?

Aurelia Metals has a three-year median payout ratio of 48% (where it is retaining 52% of its income) which is not too low or not too high. So it seems that Aurelia Metals is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Along with seeing a growth in earnings, Aurelia Metals only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 17% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 17%, over the same period.

Summary

In total, it does look like Aurelia Metals has some positive aspects to its business. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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.

This article by Simply Wall St is general in nature. 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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