Weak Financial Prospects Seem To Be Dragging Down IPH Limited (ASX:IPH) Stock

With its stock down 12% over the past three months, it is easy to disregard IPH (ASX:IPH). Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. Specifically, we decided to study IPH'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.

Check out our latest analysis for IPH

How To Calculate Return On Equity?

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:

11% = AU$65m ÷ AU$577m (Based on the trailing twelve months to June 2023).

The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.11 in profit.

Why Is ROE Important For 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.

A Side By Side comparison of IPH's Earnings Growth And 11% ROE

To begin with, IPH seems to have a respectable ROE. Even so, when compared with the average industry ROE of 16%, we aren't very excited. On further research, we found that IPH's net income growth of 4.7% over the past five years is quite low. Not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So there might be other reasons for the earnings growth to be low. Such as, the company pays out a huge portion of its earnings as dividends, or is facing competitive pressures.

As a next step, we compared IPH's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 8.7% in the same period.

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). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is IPH fairly valued? This infographic on the company's intrinsic value has everything you need to know.

Is IPH Efficiently Re-investing Its Profits?

IPH has a very high three-year median payout ratio of 119%suggesting that the company's shareholders are getting paid from more than just the company's income. This is quite a risky position to be in. Our risks dashboard should have the 3 risks we have identified for IPH.

Additionally, IPH has paid dividends over a period of nine years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 77% 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 20%, over the same period.

Summary

On the whole, IPH's performance is quite a big let-down. The company has shown a disappointing growth in its earnings as a result of it retaining little to almost none of its profits. So, the decent ROE it does have, is not much useful to investors given that the company is reinvesting very little into its business. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team (at) simplywallst.com.

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.