With its stock down 8.3% over the past three months, it is easy to disregard IPH (ASX:IPH). It is possible that the markets have ignored the company's differing financials and decided to lean-in to the negative sentiment. Long-term fundamentals are usually what drive market outcomes, so it's worth paying close attention. Particularly, we will be paying attention to IPH's ROE today.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
How Do You Calculate Return On Equity?
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 IPH is:
12% = AU$57m ÷ AU$483m (Based on the trailing twelve months to December 2022).
The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.12 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. 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. 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.
IPH's Earnings Growth And 12% ROE
At first glance, IPH seems to have a decent ROE. Even so, when compared with the average industry ROE of 16%, we aren't very excited. Although, we can see that IPH saw a modest net income growth of 5.0% over the past five years. We reckon that there could be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently. Bear in mind, the company does have a respectable level of ROE. It is just that the industry ROE is higher. So this also does lend some color to the fairly high earnings growth seen by the company.
We then compared IPH's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 13% in the same period, which is a bit concerning.
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. Is IPH fairly valued compared to other companies? These 3 valuation measures might help you decide.
Is IPH Efficiently Re-investing Its Profits?
The really high three-year median payout ratio of 119% for IPH suggests that the company is paying its shareholders more than what it is earning. However, this hasn't really hampered its ability to grow as we saw earlier. That being said, the high payout ratio could be worth keeping an eye on in case the company is unable to keep up its current growth momentum. You can see the 3 risks we have identified for IPH by visiting our risks dashboard for free on our platform here.
Besides, IPH has been paying dividends over a period of eight years. This shows that the company is committed to sharing profits with its shareholders. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 76% over the next three years. As a result, the expected drop in IPH's payout ratio explains the anticipated rise in the company's future ROE to 20%, over the same period.
In total, we're a bit ambivalent about IPH's performance. As noted earlier, its earnings growth has been quite decent, and the decent ROE does contribute to that growth. Still, the company invests little to almost none of its profits. This could potentially reduce the odds that the company continues to see the same level of growth in the future. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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.
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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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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