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IPG Photonics' (NASDAQ:IPGP) stock is up by a considerable 48% over the past three months. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. In this article, we decided to focus on IPG Photonics' ROE.
Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors’ money. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.
How Is ROE Calculated?
The formula for return on equity is:
Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity
So, based on the above formula, the ROE for IPG Photonics is:
6.9% = US$162m ÷ US$2.4b (Based on the trailing twelve months to March 2020).
The 'return' is the profit over the last twelve months. So, this means that for every $1 of its shareholder's investments, the company generates a profit of $0.07.
Why Is ROE Important For Earnings Growth?
So far, we've learned that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. 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.
A Side By Side comparison of IPG Photonics' Earnings Growth And 6.9% ROE
On the face of it, IPG Photonics' ROE is not much to talk about. We then compared the company's ROE to the broader industry and were disappointed to see that the ROE is lower than the industry average of 9.9%. Accordingly, IPG Photonics' low net income growth of 4.1% over the past five years can possibly be explained by the low ROE amongst other factors.
As a next step, we compared IPG Photonics' net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 12% in the same period.
Earnings growth is a huge factor in stock valuation. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if IPG Photonics is trading on a high P/E or a low P/E, relative to its industry.
Is IPG Photonics Making Efficient Use Of Its Profits?
IPG Photonics doesn't pay any dividend, which means that it is retaining all of its earnings. However, this doesn't explain the low earnings growth the company has seen. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.
On the whole, we feel that the performance shown by IPG Photonics can be open to many interpretations. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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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