Can Integral Diagnostics Limited (ASX:IDX) Continue To Outperform Its Industry?

The content of this article will benefit those of you who are starting to educate yourself about investing in the stock market and want to better understand how you can grow your money by investing in Integral Diagnostics Limited (ASX:IDX).

With an ROE of 16.24%, Integral Diagnostics Limited (ASX:IDX) outpaced its own industry which delivered a less exciting 11.41% over the past year. Though, the impressiveness of IDX’s ROE is contingent on whether this industry-beating level can be sustained. This can be measured by looking at the company’s financial leverage. With more debt, IDX can invest even more and earn more money, thus pushing up its returns. However, ROE only measures returns against equity, not debt. This can be distorted, so let’s take a look at it further. See our latest analysis for Integral Diagnostics

Peeling the layers of ROE – trisecting a company’s profitability

Return on Equity (ROE) weighs Integral Diagnostics’s profit against the level of its shareholders’ equity. An ROE of 16.24% implies A$0.16 returned on every A$1 invested, so the higher the return, the better. Investors that are diversifying their portfolio based on industry may want to maximise their return in the Healthcare Services sector by choosing the highest returning stock. However, this can be deceiving as each company has varying costs of equity and debt levels, which could exaggeratedly push up ROE at the same time as accumulating high interest expense.

Return on Equity = Net Profit ÷ Shareholders Equity

Returns are usually compared to costs to measure the efficiency of capital. Integral Diagnostics’s cost of equity is 8.55%. Since Integral Diagnostics’s return covers its cost in excess of 7.69%, its use of equity capital is efficient and likely to be sustainable. Simply put, Integral Diagnostics pays less for its capital than what it generates in return. ROE can be split up into three useful ratios: net profit margin, asset turnover, and financial leverage. This is called the Dupont Formula:

Dupont Formula

ROE = profit margin × asset turnover × financial leverage

ROE = (annual net profit ÷ sales) × (sales ÷ assets) × (assets ÷ shareholders’ equity)

ROE = annual net profit ÷ shareholders’ equity

ASX:IDX Last Perf June 29th 18
ASX:IDX Last Perf June 29th 18

Essentially, profit margin shows how much money the company makes after paying for all its expenses. Asset turnover reveals how much revenue can be generated from Integral Diagnostics’s asset base. And finally, financial leverage is simply how much of assets are funded by equity, which exhibits how sustainable the company’s capital structure is. We can determine if Integral Diagnostics’s ROE is inflated by borrowing high levels of debt. Generally, a balanced capital structure means its returns will be sustainable over the long run. We can examine this by looking at Integral Diagnostics’s debt-to-equity ratio. Currently the ratio stands at 72.91%, which is reasonable. This means Integral Diagnostics has not taken on too much leverage, and its above-average ROE is driven by its ability to grow its profit without a huge debt burden.

ASX:IDX Historical Debt June 29th 18
ASX:IDX Historical Debt June 29th 18

Next Steps:

ROE is a simple yet informative ratio, illustrating the various components that each measure the quality of the overall stock. Integral Diagnostics’s ROE is impressive relative to the industry average and also covers its cost of equity. ROE is not likely to be inflated by excessive debt funding, giving shareholders more conviction in the sustainability of high returns. ROE is a helpful signal, but it is definitely not sufficient on its own to make an investment decision.

For Integral Diagnostics, there are three key factors you should further research:

  1. Financial Health: Does it have a healthy balance sheet? Take a look at our free balance sheet analysis with six simple checks on key factors like leverage and risk.
  2. Valuation: What is Integral Diagnostics worth today? Is the stock undervalued, even when its growth outlook is factored into its intrinsic value? The intrinsic value infographic in our free research report helps visualize whether Integral Diagnostics is currently mispriced by the market.
  3. Other High-Growth Alternatives : Are there other high-growth stocks you could be holding instead of Integral Diagnostics? Explore our interactive list of stocks with large growth potential to get an idea of what else is out there you may be missing!