Is Weakness In Innovative Solutions and Support, Inc. (NASDAQ:ISSC) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

With its stock down 13% over the past month, it is easy to disregard Innovative Solutions and Support (NASDAQ:ISSC). However, stock prices are usually driven by a company’s financial performance over the long term, which in this case looks quite promising. Specifically, we decided to study Innovative Solutions and Support'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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

Check out our latest analysis for Innovative Solutions and Support

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 Innovative Solutions and Support is:

12% = US$3.3m ÷ US$28m (Based on the trailing twelve months to September 2020).

The 'return' refers to a company's earnings over the last year. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.12.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Innovative Solutions and Support's Earnings Growth And 12% ROE

At first glance, Innovative Solutions and Support seems to have a decent ROE. And on comparing with the industry, we found that the the average industry ROE is similar at 11%. Consequently, this likely laid the ground for the impressive net income growth of 29% seen over the past five years by Innovative Solutions and Support. However, there could also be other drivers behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Innovative Solutions and Support's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 17%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Innovative Solutions and Support fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Innovative Solutions and Support Making Efficient Use Of Its Profits?

Summary

Overall, we are quite pleased with Innovative Solutions and Support's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see substantial growth in its earnings. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Not to forget, share price outcomes are also dependent on the potential risks a company may face. So it is important for investors to be aware of the risks involved in the business. Our risks dashboard would have the 3 risks we have identified for Innovative Solutions and Support.

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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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