Are Poor Financial Prospects Dragging Down Instituto de Diagnóstico S.A. (SNSE:INDISA Stock?

Instituto de Diagnóstico (SNSE:INDISA) has had a rough three months with its share price down 8.3%. Given that stock prices are usually driven by a company’s fundamentals over the long term, which in this case look pretty weak, we decided to study the company's key financial indicators. Specifically, we decided to study Instituto de Diagnóstico's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Instituto de Diagnóstico

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 Instituto de Diagnóstico is:

5.7% = CL$4.7b ÷ CL$82b (Based on the trailing twelve months to June 2020).

The 'return' is the amount earned after tax over the last twelve months. That means that for every CLP1 worth of shareholders' equity, the company generated CLP0.06 in profit.

What Is The Relationship Between ROE And 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. 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.

Instituto de Diagnóstico's Earnings Growth And 5.7% ROE

As you can see, Instituto de Diagnóstico's ROE looks pretty weak. Even compared to the average industry ROE of 10%, the company's ROE is quite dismal. For this reason, Instituto de Diagnóstico's five year net income decline of 3.8% is not surprising given its lower ROE. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

However, when we compared Instituto de Diagnóstico's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 8.2% in the same period. This is quite worrisome.

Earnings growth is an important metric to consider when valuing a stock. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about Instituto de Diagnóstico's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Instituto de Diagnóstico Making Efficient Use Of Its Profits?

With a high three-year median payout ratio of 50% (implying that 50% of the profits are retained), most of Instituto de Diagnóstico's profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely. To know the 4 risks we have identified for Instituto de Diagnóstico visit our risks dashboard for free.

Additionally, Instituto de Diagnóstico 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.

Conclusion

Overall, we would be extremely cautious before making any decision on Instituto de Diagnóstico. Because the company is not reinvesting much into the business, and given the low ROE, it's not surprising to see the lack or absence of growth in its earnings. Up till now, we've only made a short study of the company's growth data. To gain further insights into Instituto de Diagnóstico's past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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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