Lynas Rare Earths' (ASX:LYC) stock is up by a considerable 17% over the past month. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. Particularly, we will be paying attention to Lynas Rare Earths' 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Lynas Rare Earths

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 Lynas Rare Earths is:

1.8% = AU$17m ÷ AU$964m (Based on the trailing twelve months to December 2020).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.02 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.

A Side By Side comparison of Lynas Rare Earths' Earnings Growth And 1.8% ROE

As you can see, Lynas Rare Earths' ROE looks pretty weak. Even compared to the average industry ROE of 15%, the company's ROE is quite dismal. In spite of this, Lynas Rare Earths was able to grow its net income considerably, at a rate of 53% in the last five years. We reckon that there could be other factors at play here. Such as - high earnings retention or an efficient management in place.

We then compared Lynas Rare Earths' net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a growth rate of 29% 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Lynas Rare Earths is trading on a high P/E or a low P/E, relative to its industry.

Is Lynas Rare Earths Making Efficient Use Of Its Profits?

Summary

In total, it does look like Lynas Rare Earths has some positive aspects to its business. Even in spite of the low rate of return, the company has posted impressive earnings growth as a result of reinvesting heavily into its business. The latest industry analyst forecasts show that the company is expected to maintain its current growth rate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.

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.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.