Will Weakness in IDP Education Limited's (ASX:IEL) Stock Prove Temporary Given Strong Fundamentals?

IDP Education (ASX:IEL) has had a rough week with its share price down 5.2%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on IDP Education'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for IDP Education

How Is ROE Calculated?

ROE 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 IDP Education is:

27% = AU$134m ÷ AU$497m (Based on the trailing twelve months to December 2022).

The 'return' is the income the business earned over the last year. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.27 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. 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 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 IDP Education's Earnings Growth And 27% ROE

To begin with, IDP Education has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 4.8% the company's ROE is quite impressive. This likely paved the way for the modest 13% net income growth seen by IDP Education over the past five years. growth

As a next step, we compared IDP Education'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 3.8%.

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. Doing so will help them establish if the stock's future looks promising or ominous. Is IDP Education fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is IDP Education Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 63% (or a retention ratio of 37%) for IDP Education suggests that the company's growth wasn't really hampered despite it returning most of its income to its shareholders.

Besides, IDP Education has been paying dividends over a period of six 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 over the next three years is expected to be approximately 67%. Still, forecasts suggest that IDP Education's future ROE will rise to 39% even though the the company's payout ratio is not expected to change by much.

Summary

On the whole, we feel that IDP Education's performance has been quite good. In particular, its high ROE is quite noteworthy and also the probable explanation behind its considerable earnings growth. Yet, the company is retaining a small portion of its profits. Which means that the company has been able to grow its earnings in spite of it, so that's not too bad. 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.

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.