# Incitec Pivot Limited's (ASX:IPL) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

By
Simply Wall St
Published
July 19, 2021

Incitec Pivot (ASX:IPL) has had a great run on the share market with its stock up by a significant 6.8% over the last month. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on Incitec Pivot's ROE.

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 Incitec Pivot

### How Do You 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 Incitec Pivot is:

1.8% = AU\$95m ÷ AU\$5.2b (Based on the trailing twelve months to March 2021).

The 'return' is the yearly profit. Another way to think of that is that for every A\$1 worth of equity, the company was able to earn A\$0.02 in profit.

### What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. Assuming everything else remains unchanged, the higher the ROE and profit retention, the higher the growth rate of a company compared to companies that don't necessarily bear these characteristics.

### A Side By Side comparison of Incitec Pivot's Earnings Growth And 1.8% ROE

It is quite clear that Incitec Pivot's ROE is rather low. Even compared to the average industry ROE of 6.0%, the company's ROE is quite dismal. Therefore, it might not be wrong to say that the five year net income decline of 13% seen by Incitec Pivot was possibly a result of it having a lower ROE. We reckon that there could also be other factors at play here. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

So, as a next step, we compared Incitec Pivot's performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 36% in the same period.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 Incitec Pivot's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

### Is Incitec Pivot Efficiently Re-investing Its Profits?

In spite of a normal three-year median payout ratio of 50% (that is, a retention ratio of 50%), the fact that Incitec Pivot's earnings have shrunk is quite puzzling. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.

Additionally, Incitec Pivot has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 49% of its profits over the next three years. However, Incitec Pivot's ROE is predicted to rise to 7.8% despite there being no anticipated change in its payout ratio.

### Summary

On the whole, we feel that the performance shown by Incitec Pivot can be open to many interpretations. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.

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This article by Simply Wall St is general in nature. 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.
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