Most readers would already know that IPH's (ASX:IPH) stock increased by 4.7% 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 IPH's ROE today.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
How Is ROE Calculated?
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 IPH is:
12% = AU$51m ÷ AU$429m (Based on the trailing twelve months to December 2021).
The 'return' is the yearly profit. 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.
Why Is ROE Important For 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. 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.
IPH's Earnings Growth And 12% ROE
To begin with, IPH seems to have a respectable ROE. Even when compared to the industry average of 12% the company's ROE looks quite decent. Consequently, this likely laid the ground for the decent growth of 6.6% seen over the past five years by IPH.
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 16% 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. This then helps them determine if the stock is placed for a bright or bleak future. What is IPH worth today? The intrinsic value infographic in our free research report helps visualize whether IPH is currently mispriced by the market.
Is IPH Efficiently Re-investing Its Profits?
IPH has a very high three-year median payout ratio of 110% suggesting that the company's shareholders are getting paid from more than just the company's earnings. However, this hasn't really hampered its ability to grow as we saw earlier. 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.
Besides, IPH has been paying dividends over a period of seven 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 79% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 21%, over the same period.
Overall, we feel that IPH certainly does have some positive factors to consider. Its earnings have grown respectably as we saw earlier, probably due to its high returns. However, it does reinvest little to almost none of its profits, so we wonder what effect this could have on its future growth prospects. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. 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.