International Flavors & Fragrances (NYSE:IFF) has had a great run on the share market with its stock up by a significant 29% over the last month. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. Particularly, we will be paying attention to International Flavors & Fragrances' 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.
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 International Flavors & Fragrances is:
7.3% = US$460m ÷ US$6.3b (Based on the trailing twelve months to December 2019).
The 'return' is the yearly profit. That means that for every $1 worth of shareholders' equity, the company generated $0.07 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learnt that ROE measures how efficiently a company is generating its profits. 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.
International Flavors & Fragrances' Earnings Growth And 7.3% ROE
On the face of it, International Flavors & Fragrances' ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 12% either. For this reason, International Flavors & Fragrances' five year net income decline of 4.9% is not surprising given its lower ROE. We reckon that there could also be other factors at play here. For example, it is possible that the business has allocated capital poorly or that the company has a very high payout ratio.
So, as a next step, we compared International Flavors & Fragrances' performance against the industry and were disappointed to discover that while the company has been shrinking its earnings, the industry has been growing its earnings at a rate of 9.6% in the same period.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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. What is IFF worth today? The intrinsic value infographic in our free research report helps visualize whether IFF is currently mispriced by the market.
Is International Flavors & Fragrances Efficiently Re-investing Its Profits?
Despite having a normal three-year median payout ratio of 46% (where it is retaining 54% of its profits), International Flavors & Fragrances has seen a decline in earnings as we saw above. It looks like there might be some other reasons to explain the lack in that respect. For example, the business could be in decline.
Additionally, International Flavors & Fragrances has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth. Based on the latest analysts' estimates, we found that the company's future payout ratio over the next three years is expected to hold steady at 48%. Regardless, the future ROE for International Flavors & Fragrances is predicted to rise to 11% despite there being not much change expected in its payout ratio.
Overall, we have mixed feelings about International Flavors & Fragrances. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page for the company.
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