It is hard to get excited after looking at Adcock Ingram Holdings' (JSE:AIP) recent performance, when its stock has declined 9.0% over the past three months. But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. In this article, we decided to focus on Adcock Ingram Holdings' ROE.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

Check out our latest analysis for Adcock Ingram Holdings

How To Calculate Return On Equity?

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 Adcock Ingram Holdings is:

16% = R874m ÷ R5.5b (Based on the trailing twelve months to December 2023).

The 'return' is the profit over the last twelve months. That means that for every ZAR1 worth of shareholders' equity, the company generated ZAR0.16 in profit.

What Is The Relationship Between ROE And 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. 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.

A Side By Side comparison of Adcock Ingram Holdings' Earnings Growth And 16% ROE

At first glance, Adcock Ingram Holdings' ROE doesn't look very promising. However, given that the company's ROE is similar to the average industry ROE of 16%, we may spare it some thought. Having said that, Adcock Ingram Holdings has shown a modest net income growth of 6.8% over the past five years. Given the slightly low ROE, it is likely that there could be some other aspects that are driving this growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then performed a comparison between Adcock Ingram Holdings' net income growth with the industry, which revealed that the company's growth is similar to the average industry growth of 7.8% in the same 5-year period.

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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Adcock Ingram Holdings fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Adcock Ingram Holdings Using Its Retained Earnings Effectively?

With a three-year median payout ratio of 43% (implying that the company retains 57% of its profits), it seems that Adcock Ingram Holdings is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Moreover, Adcock Ingram Holdings is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years. Upon studying the latest analysts' consensus data, we found that the company is expected to keep paying out approximately 41% of its profits over the next three years. Therefore, the company's future ROE is also not expected to change by much with analysts predicting an ROE of 15%.

Conclusion

In total, it does look like Adcock Ingram Holdings has some positive aspects to its business. With a high rate of reinvestment, albeit at a low ROE, the company has managed to see a considerable growth in its earnings. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 1 risk we have identified for Adcock Ingram Holdings visit our risks dashboard for free.

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This article by Simply Wall St is general in nature. We provide commentary based on historical data and analyst forecasts only using an unbiased methodology and our articles are not intended to be financial advice. 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.