Most readers would already be aware that IRESS' (ASX:IRE) stock increased significantly by 12% over the past month. However, we wonder if the company's inconsistent financials would have any adverse impact on the current share price momentum. Particularly, we will be paying attention to IRESS' ROE today.
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?
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 IRESS is:
11% = AU$61m ÷ AU$551m (Based on the trailing twelve months to June 2020).
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$0.11 in profit.
What Has ROE Got To Do With Earnings Growth?
We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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.
IRESS' Earnings Growth And 11% ROE
To begin with, IRESS seems to have a respectable ROE. Even when compared to the industry average of 13% the company's ROE looks quite decent. Despite the moderate return on equity, IRESS has posted a net income growth of 3.7% over the past five years. So, there could be some other factors at play that could be impacting the company's growth. For instance, the company pays out a huge portion of its earnings as dividends, or is faced with competitive pressures.
We then compared IRESS' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 11% in the same period, which is a bit concerning.
Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Has the market priced in the future outlook for IRE? You can find out in our latest intrinsic value infographic research report.
Is IRESS Efficiently Re-investing Its Profits?
IRESS' very high three-year median payout ratio of 124% suggests that the company is paying its shareholders more than what it is earning and it definitely contributes to the low earnings growth seen by the company. This is indicative of risk. You can see the 2 risks we have identified for IRESS by visiting our risks dashboard for free on our platform here.
In addition, IRESS 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 102% of its profits over the next three years. However, IRESS' ROE is predicted to rise to 16% despite there being no anticipated change in its payout ratio.
Overall, we have mixed feelings about IRESS. Despite the high ROE, the company has a disappointing earnings growth number, due to its poor rate of reinvestment into its business. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. 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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