Iluka Resources Limited's (ASX:ILU) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

Iluka Resources (ASX:ILU) has had a rough three months with its share price down 29%. 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. Specifically, we decided to study Iluka Resources' 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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Iluka Resources

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 Iluka Resources is:

22% = AU$435m ÷ AU$2.0b (Based on the trailing twelve months to June 2023).

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$0.22 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.

Iluka Resources' Earnings Growth And 22% ROE

To start with, Iluka Resources' ROE looks acceptable. Especially when compared to the industry average of 10% the company's ROE looks pretty impressive. Probably as a result of this, Iluka Resources was able to see an impressive net income growth of 31% over the last five years. We reckon that there could also be other factors at play here. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Iluka Resources' 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 25%.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Iluka Resources''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Iluka Resources Using Its Retained Earnings Effectively?

The three-year median payout ratio for Iluka Resources is 30%, which is moderately low. The company is retaining the remaining 70%. This suggests that its dividend is well covered, and given the high growth we discussed above, it looks like Iluka Resources is reinvesting its earnings efficiently.

Additionally, Iluka Resources has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 28%. Regardless, Iluka Resources' ROE is speculated to decline to 14% despite there being no anticipated change in its payout ratio.

Summary

On the whole, we feel that Iluka Resources' performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business, and at a high rate of return. Unsurprisingly, this has led to an impressive earnings growth. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.