Should Weakness in Integral Diagnostics Limited's (ASX:IDX) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

Integral Diagnostics (ASX:IDX) has had a rough three months with its share price down 37%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Integral Diagnostics' ROE today.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Integral Diagnostics

How Is ROE Calculated?

The formula for return on equity is:

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

So, based on the above formula, the ROE for Integral Diagnostics is:

6.7% = AU$25m ÷ AU$373m (Based on the trailing twelve months to June 2023).

The 'return' is the profit over the last twelve months. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.07.

Why Is ROE Important For 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. 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.

Integral Diagnostics' Earnings Growth And 6.7% ROE

At first glance, Integral Diagnostics' ROE doesn't look very promising. However, its ROE is similar to the industry average of 6.9%, so we won't completely dismiss the company. On the other hand, Integral Diagnostics reported a fairly low 3.6% net income growth over the past five years. Bear in mind, the company's ROE is not very high . Hence, this does provide some context to low earnings growth seen by the company.

Next, on comparing with the industry net income growth, we found that Integral Diagnostics' growth is quite high when compared to the industry average growth of 2.4% in the same period, which is great to see.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Integral Diagnostics''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Integral Diagnostics Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 76% (that is, the company retains only 24% of its income) over the past three years for Integral Diagnostics suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.

In addition, Integral Diagnostics has been paying dividends over a period of seven years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 70% of its profits over the next three years. Regardless, the future ROE for Integral Diagnostics is predicted to rise to 11% despite there being not much change expected in its payout ratio.

Summary

Overall, we feel that Integral Diagnostics certainly does have some positive factors to consider. While no doubt its earnings growth is pretty substantial, we do feel that the reinvestment rate is pretty low, meaning, the earnings growth number could have been significantly higher had the company been retaining more of its profits. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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. 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.