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With its stock down 9.6% over the past three months, it is easy to disregard Incitec Pivot (ASX:IPL). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. In this article, we decided to focus on Incitec Pivot'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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.
Check out our latest analysis for Incitec Pivot
How To 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 Incitec Pivot is:
4.3% = AU$277m ÷ AU$6.4b (Based on the trailing twelve months to September 2023).
The 'return' is the profit over the last twelve months. That means that for every A$1 worth of shareholders' equity, the company generated A$0.04 in profit.
What Has ROE Got To Do With 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.
Incitec Pivot's Earnings Growth And 4.3% ROE
At first glance, Incitec Pivot's ROE doesn't look very promising. Yet, a closer study shows that the company's ROE is similar to the industry average of 5.3%. Looking at Incitec Pivot's exceptional 35% five-year net income growth in particular, we are definitely impressed. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. Such as - high earnings retention or an efficient management in place.
As a next step, we compared Incitec Pivot's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 14%.
Earnings growth is a huge factor in stock valuation. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). This then helps them determine if the stock is placed for a bright or bleak future. Has the market priced in the future outlook for IPL? You can find out in our latest intrinsic value infographic research report.