Should Weakness in Adcock Ingram Holdings Limited's (JSE:AIP) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

With its stock down 15% over the past month, it is easy to disregard Adcock Ingram Holdings (JSE:AIP). However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. In this article, we decided to focus on Adcock Ingram Holdings' ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

Check out our latest analysis for Adcock Ingram Holdings

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 Adcock Ingram Holdings is:

14% = R760m ÷ R5.5b (Based on the trailing twelve months to December 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each ZAR1 of shareholders' capital it has, the company made ZAR0.14 in profit.

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.

Adcock Ingram Holdings' Earnings Growth And 14% ROE

On the face of it, Adcock Ingram Holdings' ROE is not much to talk about. However, its ROE is similar to the industry average of 17%, so we won't completely dismiss the company. Having said that, Adcock Ingram Holdings has shown a modest net income growth of 5.8% over the past five years. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

As a next step, we compared Adcock Ingram Holdings' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 17% in the same period.

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. Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Adcock Ingram Holdings''s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Adcock Ingram Holdings Making Efficient Use Of Its Profits?

Adcock Ingram Holdings has a three-year median payout ratio of 44%, which implies that it retains the remaining 56% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Additionally, Adcock Ingram Holdings has paid dividends over a period of nine years which means that the company is pretty serious about sharing its profits with shareholders. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 45%. Accordingly, forecasts suggest that Adcock Ingram Holdings' future ROE will be 16% which is again, similar to the current ROE.

Summary

In total, it does look like Adcock Ingram Holdings has some positive aspects to its business. Specifically, its fairly high earnings growth number, which no doubt was backed by the company's high earnings retention. Still, the low ROE means that all that reinvestment is not reaping a lot of benefit to the investors. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. Our risks dashboard will have the 1 risk we have identified for Adcock Ingram Holdings.

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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.