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IPH Limited's (ASX:IPH) Stock Is Rallying But Financials Look Ambiguous: Will The Momentum Continue?

IPH (ASX:IPH) has had a great run on the share market with its stock up by a significant 11% over the last month. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. In this article, we decided to focus on IPH's 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. Put another way, it reveals the company's success at turning shareholder investments into profits.

Check out our latest analysis for IPH

How Do You Calculate Return On Equity?

The formula for ROE is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for IPH is:

13% = AU$56m ÷ AU$421m (Based on the trailing twelve months to December 2019).

The 'return' is the income the business earned over the last year. That means that for every A$1 worth of shareholders' equity, the company generated A$0.13 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learnt that ROE is a measure of a company's profitability. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

IPH's Earnings Growth And 13% ROE

To begin with, IPH seems to have a respectable ROE. Be that as it may, the company's ROE is still quite lower than the industry average of 17%. IPH was still able to see a decent net income growth of 11% over the past five years. So, there might be other aspects that are positively influencing earnings growth. For instance, the company has a low payout ratio or is being managed efficiently. Bear in mind, the company does have a respectable level of ROE. It is just that the industry ROE is higher. So this also provides some context to the earnings growth seen by the company.

Next, on comparing with the industry net income growth, we found that IPH's reported growth was lower than the industry growth of 25% in the same period, which is not something we like to see.

ASX:IPH Past Earnings Growth July 8th 2020
ASX:IPH Past Earnings Growth July 8th 2020

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. This then helps them determine if the stock is placed for a bright or bleak future. What is IPH worth today? The intrinsic value infographic in our free research report helps visualize whether IPH is currently mispriced by the market.

Is IPH Using Its Retained Earnings Effectively?

While IPH has a three-year median payout ratio of 98% (which means it retains 2.1% of profits), the company has still seen a fair bit of earnings growth in the past, meaning that its high payout ratio hasn't hampered its ability to grow.

Additionally, IPH has paid dividends over a period of five years which means that the company is pretty serious about sharing its profits with shareholders. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 81% of its profits over the next three years. However, IPH's ROE is predicted to rise to 22% despite there being no anticipated change in its payout ratio.

Summary

Overall, we have mixed feelings about IPH. As noted earlier, its earnings growth has been quite decent, and the decent ROE does contribute to that growth. Still, the company invests little to almost none of its profits. This could potentially reduce the odds that the company continues to see the same level of growth in the future. That being so, the latest analyst forecasts show that the company will continue to see an expansion in its earnings. To know more about the company's future earnings growth forecasts take a look at this free report on analyst forecasts for the company to find out more.

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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