Can InvoCare Limited's (ASX:IVC) Weak Financials Pull The Plug On The Stock's Current Momentum On Its Share Price?
InvoCare (ASX:IVC) has had a great run on the share market with its stock up by a significant 19% over the last three months. However, we decided to pay close attention to its weak financials as we are doubtful that the current momentum will keep up, given the scenario. Specifically, we decided to study InvoCare's ROE in this article.
Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.
Check out our latest analysis for InvoCare
How Is ROE Calculated?
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 InvoCare is:
0.9% = AU$4.8m ÷ AU$550m (Based on the trailing twelve months to June 2020).
The 'return' is the income the business earned over the last year. One way to conceptualize this is that for each A$1 of shareholders' capital it has, the company made A$0.01 in profit.
What Is The Relationship Between ROE And Earnings Growth?
Thus far, we have learned 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. 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.
InvoCare's Earnings Growth And 0.9% ROE
It is hard to argue that InvoCare's ROE is much good in and of itself. Not just that, even compared to the industry average of 9.1%, the company's ROE is entirely unremarkable. Given the circumstances, the significant decline in net income by 7.0% seen by InvoCare over the last five years is not surprising. We believe that there also might be other aspects that are negatively influencing the company's earnings prospects. Such as - low earnings retention or poor allocation of capital.
However, when we compared InvoCare's growth with the industry we found that while the company's earnings have been shrinking, the industry has seen an earnings growth of 18% in the same period. This is quite worrisome.
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 IVC worth today? The intrinsic value infographic in our free research report helps visualize whether IVC is currently mispriced by the market.
Is InvoCare Making Efficient Use Of Its Profits?
InvoCare's declining earnings is not surprising given how the company is spending most of its profits in paying dividends, judging by its three-year median payout ratio of 70% (or a retention ratio of 30%). With only very little left to reinvest into the business, growth in earnings is far from likely. To know the 5 risks we have identified for InvoCare visit our risks dashboard for free.
In addition, InvoCare 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. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 82% of its profits over the next three years. Still, forecasts suggest that InvoCare's future ROE will rise to 12% even though the the company's payout ratio is not expected to change by much.
Summary
On the whole, InvoCare's performance is quite a big let-down. As a result of its low ROE and lack of mich reinvestment into the business, the company has seen a disappointing earnings growth rate. Having said that, looking at current analyst estimates, we found that the company's earnings growth rate is expected to see a huge improvement. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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