Will Weakness in Iluka Resources Limited's (ASX:ILU) Stock Prove Temporary Given Strong Fundamentals?

Iluka Resources (ASX:ILU) has had a rough three months with its share price down 9.2%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Iluka Resources' ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Iluka Resources

How To Calculate Return On Equity?

Return on equity 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 Iluka Resources is:

16% = AU$343m ÷ AU$2.2b (Based on the trailing twelve months to December 2023).

The 'return' is the income the business earned over the last year. That means that for every A$1 worth of shareholders' equity, the company generated A$0.16 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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 Iluka Resources' Earnings Growth And 16% ROE

At first glance, Iluka Resources seems to have a decent ROE. Further, the company's ROE compares quite favorably to the industry average of 10%. 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 believe that there might also be other aspects that are positively influencing the company's earnings growth. Such as - high earnings retention or an efficient management in place.

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 20%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. This then helps them determine if the stock is placed for a bright or bleak future. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Iluka Resources is trading on a high P/E or a low P/E, relative to its industry.

Is Iluka Resources Efficiently Re-investing Its Profits?

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.

Besides, Iluka Resources has been paying dividends for at least ten years or more. 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 is expected to rise to 37% over the next three years. Accordingly, the expected increase in the payout ratio explains the expected decline in the company's ROE to 9.2%, over the same period.

Summary

Overall, we are quite pleased with Iluka Resources' performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings growth is expected to slow down. 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.

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