IMCD (AMS:IMCD) has had a rough three months with its share price down 6.1%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study IMCD's 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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Is ROE Calculated?
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 IMCD is:
17% = €289m ÷ €1.7b (Based on the trailing twelve months to June 2023).
The 'return' is the profit over the last twelve months. That means that for every €1 worth of shareholders' equity, the company generated €0.17 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. 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. 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 IMCD's Earnings Growth And 17% ROE
To start with, IMCD's ROE looks acceptable. And on comparing with the industry, we found that the the average industry ROE is similar at 15%. This certainly adds some context to IMCD's exceptional 28% net income growth seen over the past five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.
As a next step, we compared IMCD's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 19%.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. What is IMCD worth today? The intrinsic value infographic in our free research report helps visualize whether IMCD is currently mispriced by the market.
Is IMCD Efficiently Re-investing Its Profits?
IMCD's three-year median payout ratio is a pretty moderate 42%, meaning the company retains 58% of its income. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like IMCD is reinvesting its earnings efficiently.
Besides, IMCD has been paying dividends over a period of eight years. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 33% over the next three years. However, the company's ROE is not expected to change by much despite the lower expected payout ratio.
Overall, we are quite pleased with IMCD's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.