Yahoo Finance Is Central Iron Ore Limited's (CVE:CIO) Recent Price Movement Underpinned By Its Weak Fundamentals?
Central Iron Ore (CVE:CIO) has had a rough three months with its share price down 33%. We, however decided to study the company's financials to determine if they have got anything to do with the price decline. Fundamentals usually dictate market outcomes so it makes sense to study the company's financials. In this article, we decided to focus on Central Iron Ore's ROE.
Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. 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 Central Iron Ore
How Is ROE Calculated?
ROE 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 Central Iron Ore is:
4.8% = AU$102k ÷ AU$2.1m (Based on the trailing twelve months to June 2020).
The 'return' is the profit over the last twelve months. So, this means that for every CA$1 of its shareholder's investments, the company generates a profit of CA$0.05.
Why Is ROE Important For 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 Central Iron Ore's Earnings Growth And 4.8% ROE
On the face of it, Central Iron Ore's ROE is not much to talk about. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 8.1%. For this reason, Central Iron Ore's five year net income decline of 7.4% is not surprising given its lower ROE. However, there could also be other factors causing the earnings to decline. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.
That being said, we compared Central Iron Ore's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 31% in the same period.
Earnings growth is a huge factor in stock valuation. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Central Iron Ore's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Central Iron Ore Using Its Retained Earnings Effectively?
Conclusion
On the whole, we feel that the performance shown by Central Iron Ore can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. Our risks dashboard would have the 4 risks we have identified for Central Iron Ore.
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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