Are iomart Group plc's (LON:IOM) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

With its stock down 3.7% over the past month, it is easy to disregard iomart Group (LON:IOM). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to iomart Group'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for iomart Group

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 iomart Group is:

10% = UK£11m ÷ UK£113m (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each £1 of shareholders' capital it has, the company made £0.10 in profit.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

iomart Group's Earnings Growth And 10% ROE

To begin with, iomart Group seems to have a respectable ROE. Further, the company's ROE is similar to the industry average of 10%. Despite the modest returns, iomart Group's five year net income growth was quite low, averaging at only 4.4%. We reckon that a low growth, when returns are moderate could be the result of certain circumstances like low earnings retention or poor allocation of capital.

Next, on comparing with the industry net income growth, we found that iomart Group's reported growth was lower than the industry growth of 21% in the same period, which is not something we like to see.

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

Is iomart Group Efficiently Re-investing Its Profits?

The high three-year median payout ratio of 62% (that is, the company retains only 38% of its income) over the past three years for iomart Group suggests that the company's earnings growth was lower as a result of paying out a majority of its earnings.

Moreover, iomart Group 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 drop to 40% over the next three years. Accordingly, the expected drop in the payout ratio explains the expected increase in the company's ROE to 18%, over the same period.

Conclusion

On the whole, we do feel that iomart Group has some positive attributes. Yet, the low earnings growth is a bit concerning, especially given that the company has a high rate of return. Investors could have benefitted from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining a small portion of its profits. Having said that, looking at the current analyst estimates, we found that the company's earnings are expected to gain momentum. 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. 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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