Are IPH Limited's (ASX:IPH) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

It is hard to get excited after looking at IPH's (ASX:IPH) recent performance, when its stock has declined 12% over the past three months. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on IPH's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Put another way, it reveals the company's success at turning shareholder investments into profits.

See our latest analysis for IPH

How Is ROE Calculated?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for IPH is:

13% = AU$54m ÷ AU$422m (Based on the trailing twelve months to December 2020).

The 'return' is the yearly profit. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.13 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. 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. 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 13% ROE

At first glance, IPH seems to have a decent ROE. Even when compared to the industry average of 15% the company's ROE looks quite decent. Consequently, this likely laid the ground for the decent growth of 8.9% seen over the past five years by IPH.

We then performed a comparison between IPH's net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 11% in the same period.

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. 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 Making Efficient Use Of Its Profits?

IPH's high three-year median payout ratio of 104% suggests that the company is paying out more to its shareholders than what it is making. In spite of this, the company was able to grow its earnings respectably, as we saw above. It would still be worth keeping an eye on that high payout ratio, if for some reason the company runs into problems and business deteriorates.

Moreover, IPH is determined to keep sharing its profits with shareholders which we infer from its long history of six years of paying a dividend. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 80% 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 19%, over the same period.

Summary

Overall, we feel that IPH certainly does have some positive factors to consider. Specifically, its high ROE which likely led to the growth in earnings. Bear in mind, the company reinvests little to none of its profits, which means that investors aren't necessarily reaping the full benefits of the high rate of return. 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. 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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