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IPH (ASX:IPH) has had a rough three months with its share price down 13%. To decide if this trend could continue, we decided to look at its weak fundamentals as they shape the long-term market trends. Specifically, we decided to study IPH'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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.
See our latest analysis for IPH
How To Calculate Return On Equity?
ROE 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 IPH is:
11% = AU$65m ÷ AU$577m (Based on the trailing twelve months to June 2023).
The 'return' is the amount earned after tax over the last twelve months. Another way to think of that is that for every A$1 worth of equity, the company was able to earn A$0.11 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.
A Side By Side comparison of IPH's Earnings Growth And 11% ROE
To start with, IPH's ROE looks acceptable. Be that as it may, the company's ROE is still quite lower than the industry average of 16%. Further, IPH's five year net income growth of 4.7% is on the lower side. Not to forget, the company does have a decent ROE to begin with, just that it is lower than the industry average. So there might be other reasons for the earnings growth to be low. These include low earnings retention or poor capital allocation.
We then compared IPH's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 8.7% in the same 5-year period, which is a bit concerning.
Earnings growth is a huge factor in stock valuation. 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. Has the market priced in the future outlook for IPH? You can find out in our latest intrinsic value infographic research report.