It is hard to get excited after looking at IMI’s (LON:IMI) recent performance, when its stock has declined 38% over the past three months. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on IMI’s ROE.
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. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company’s shareholders.
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 IMI is:
22% = UK£153m ÷ UK£710m (Based on the trailing twelve months to December 2019).
The ‘return’ refers to a company’s earnings over the last year. Another way to think of that is that for every £1 worth of equity, the company was able to earn £0.22 in profit.
What Is The Relationship Between ROE And Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company’s future earnings. 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. 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.
IMI’s Earnings Growth And 22% ROE
First thing first, we like that IMI has an impressive ROE. Additionally, the company’s ROE is higher compared to the industry average of 13% which is quite remarkable. Given the circumstances, we can’t help but wonder why IMI saw little to no growth in the past five years. We reckon that there could be some other factors at play here that’s limiting the company’s growth. These include low earnings retention or poor allocation of capital
We then compared IMI’s net income growth with the industry and found that the company’s growth figure is lower than the average industry growth rate of 11% in the same period, which is a bit concerning.
Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. What is IMI worth today? The intrinsic value infographic in our free research report helps visualize whether IMI is currently mispriced by the market.
Is IMI Efficiently Re-investing Its Profits?
IMI has a high three-year median payout ratio of 68% (or a retention ratio of 32%), meaning that the company is paying most of its profits as dividends to its shareholders. This does go some way in explaining why there’s been no growth in its earnings.
In addition, IMI has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Based on the latest analysts’ estimates, we found that the company’s future payout ratio over the next three years is expected to hold steady at 56%. Therefore, the company’s future ROE is also not expected to change by much with analysts predicting an ROE of 24%.
In total, it does look like IMI has some positive aspects to its business. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren’t reaping the benefits of the high rate of return. Having said that, looking at the current analyst estimates, we found that the company’s earnings are expected to gain momentum. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
If you spot an error that warrants correction, please contact the editor at email@example.com. 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. Simply Wall St has no position in the stocks mentioned.
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