Is Industria de Diseño Textil, S.A.'s (BME:ITX) Recent Stock Performance Influenced By Its Fundamentals In Any Way?

Industria de Diseño Textil (BME:ITX) has had a great run on the share market with its stock up by a significant 16% over the last three months. Given that stock prices are usually aligned with a company's financial performance in the long-term, we decided to study its financial indicators more closely to see if they had a hand to play in the recent price move. Particularly, we will be paying attention to Industria de Diseño Textil's ROE today.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Industria de Diseño Textil

How Is ROE Calculated?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Industria de Diseño Textil is:

24% = €3.9b ÷ €16b (Based on the trailing twelve months to October 2022).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every €1 worth of equity, the company was able to earn €0.24 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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 Industria de Diseño Textil's Earnings Growth And 24% ROE

To begin with, Industria de Diseño Textil has a pretty high ROE which is interesting. Secondly, even when compared to the industry average of 13% the company's ROE is quite impressive. For this reason, Industria de Diseño Textil's five year net income decline of 3.1% raises the question as to why the high ROE didn't translate into earnings growth. Based on this, we feel that there might be other reasons which haven't been discussed so far in this article that could be hampering the company's growth. These include low earnings retention or poor allocation of capital.

That being said, we compared Industria de Diseño Textil's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 13% in the same period.

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. Doing so will help them establish if the stock's future looks promising or ominous. Is Industria de Diseño Textil fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Industria de Diseño Textil Efficiently Re-investing Its Profits?

Industria de Diseño Textil's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 52% (or a retention ratio of 48%). The business is only left with a small pool of capital to reinvest - A vicious cycle that doesn't benefit the company in the long-run.

Moreover, Industria de Diseño Textil has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to rise to 86% over the next three years. Regardless, the ROE is not expected to change much for the company despite the higher expected payout ratio.

Summary

Overall, we feel that Industria de Diseño Textil certainly does have some positive factors to consider. Although, we are disappointed to see a lack of growth in earnings even in spite of a high ROE. Bear in mind, the company reinvests a small portion of its profits, which means that investors aren't reaping the benefits of the high rate of return. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts 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.