IPH (ASX:IPH) has had a rough month with its share price down 11%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to IPH'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. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.
How Do You Calculate Return On Equity?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for IPH is:
12% = AU$53m ÷ AU$430m (Based on the trailing twelve months to June 2022).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.12 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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 IPH's Earnings Growth And 12% ROE
At first glance, IPH seems to have a decent ROE. Even when compared to the industry average of 13% the company's ROE looks quite decent. This probably goes some way in explaining IPH's moderate 5.8% growth over the past five years amongst other factors.
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 12% in the same period, which is a bit concerning.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. If you're wondering about IPH's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is IPH Efficiently Re-investing Its Profits?
IPH's high three-year median payout ratio of 115% suggests that the company is paying out more to its shareholders than what it is making. Still the company's earnings have grown respectably. Although, the high payout ratio is certainly something we would keep an eye on if the company is not able to keep up its growth, or if business deteriorates. Our risks dashboard should have the 2 risks we have identified for IPH.
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. The fact that the company's ROE is expected to rise to 29% over the same period is explained by the drop in the payout ratio.
On the whole, we do feel that IPH has some positive attributes. As noted earlier, its earnings growth has been quite decent, and the high 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. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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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