Can Mixed Fundamentals Have A Negative Impact on ISA Holdings Limited (JSE:ISA) Current Share Price Momentum?

Most readers would already be aware that ISA Holdings' (JSE:ISA) stock increased significantly by 11% over the past week. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to ISA Holdings' ROE today.

ROE or return on equity is a useful tool to assess how effectively a company can generate returns on the investment it received from its shareholders. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

See our latest analysis for ISA Holdings

How To 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 ISA Holdings is:

38% = R22m ÷ R58m (Based on the trailing twelve months to February 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 ZAR0.38 in profit.

What Has ROE Got To Do With Earnings Growth?

Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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.

ISA Holdings' Earnings Growth And 38% ROE

Firstly, we acknowledge that ISA Holdings has a significantly high ROE. Second, a comparison with the average ROE reported by the industry of 9.8% also doesn't go unnoticed by us. Needless to say, we are quite surprised to see that ISA Holdings' net income shrunk at a rate of 14% over the past five years. We reckon that there could be some other factors at play here that are preventing the company's growth. Such as, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.

However, when we compared ISA Holdings' growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 15% in the same period. This is quite worrisome.

Earnings growth is an important metric to consider when valuing a stock. 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. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if ISA Holdings is trading on a high P/E or a low P/E, relative to its industry.

Is ISA Holdings Using Its Retained Earnings Effectively?

With a high three-year median payout ratio of 100% (implying that 0.2% of the profits are retained), most of ISA Holdings' profits are being paid to shareholders, which explains the company's shrinking earnings. With only very little left to reinvest into the business, growth in earnings is far from likely. You can see the 5 risks we have identified for ISA Holdings by visiting our risks dashboard for free on our platform here.

In addition, ISA Holdings has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Summary

On the whole, we feel that the performance shown by ISA Holdings can be open to many interpretations. While the company does have a high rate of return, its low earnings retention is probably what's hampering its earnings growth. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. So it may be worth checking this free detailed graph of ISA Holdings' past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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.