Do Fundamentals Have Any Role To Play In Driving Incitec Pivot Limited's (ASX:IPL) Stock Up Recently?

Incitec Pivot's (ASX:IPL) stock is up by 4.4% over the past month. As most would know, long-term fundamentals have a strong correlation with market price movements, so we decided to look at the company's key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study Incitec Pivot's 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for Incitec Pivot

How Is ROE Calculated?

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 Incitec Pivot is:

4.3% = AU$277m ÷ AU$6.4b (Based on the trailing twelve months to September 2023).

The 'return' is the profit over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.04 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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 Incitec Pivot's Earnings Growth And 4.3% ROE

On the face of it, Incitec Pivot's ROE is not much to talk about. However, its ROE is similar to the industry average of 4.3%, so we won't completely dismiss the company. Moreover, we are quite pleased to see that Incitec Pivot's net income grew significantly at a rate of 35% over the last five years. Taking into consideration that the ROE is not particularly high, we reckon that there could also be other factors at play which could be influencing the company's growth. Such as - high earnings retention or an efficient management in place.

Next, on comparing with the industry net income growth, we found that Incitec Pivot's growth is quite high when compared to the industry average growth of 6.6% in the same period, which is great to see.

Earnings growth is a huge factor in stock valuation. 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. Has the market priced in the future outlook for IPL? You can find out in our latest intrinsic value infographic research report.

Is Incitec Pivot Efficiently Re-investing Its Profits?

Incitec Pivot's significant three-year median payout ratio of 81% (where it is retaining only 19% of its income) suggests that the company has been able to achieve a high growth in earnings despite returning most of its income to shareholders.

Additionally, Incitec Pivot 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. Existing analyst estimates suggest that the company's future payout ratio is expected to drop to 50% over the next three years. The fact that the company's ROE is expected to rise to 6.3% over the same period is explained by the drop in the payout ratio.

Summary

On the whole, we do feel that Incitec Pivot has some positive attributes. That is, quite an impressive growth in earnings. However, the low profit retention means that the company's earnings growth could have been higher, had it been reinvesting a higher portion of its profits. Having said that, the company's earnings growth is expected to slow down, as forecasted in the current analyst estimates. 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.