Italtile Limited's (JSE:ITE) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

Italtile (JSE:ITE) has had a rough three months with its share price down 7.8%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Particularly, we will be paying attention to Italtile'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

View our latest analysis for Italtile

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 Italtile is:

21% = R1.7b ÷ R7.8b (Based on the trailing twelve months to June 2023).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every ZAR1 worth of equity, the company was able to earn ZAR0.21 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. 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. 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.

Italtile's Earnings Growth And 21% ROE

To start with, Italtile's ROE looks acceptable. Further, the company's ROE compares quite favorably to the industry average of 17%. This probably laid the ground for Italtile's moderate 11% net income growth seen over the past five years.

As a next step, we compared Italtile's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 13% 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. If you're wondering about Italtile's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Italtile Using Its Retained Earnings Effectively?

With a three-year median payout ratio of 40% (implying that the company retains 60% of its profits), it seems that Italtile is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Additionally, Italtile has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders.

Summary

On the whole, we feel that Italtile's performance has been quite good. 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. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. You can see the 1 risk we have identified for Italtile by visiting our risks dashboard for free on our platform here.

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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.