With its stock down 5.5% over the past three months, it is easy to disregard IDP Education (ASX:IEL). However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. Specifically, we decided to study IDP Education'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for IDP Education

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 IDP Education is:

26% = AU$134m ÷ AU$523m (Based on the trailing twelve months to June 2024).

The 'return' is the profit over the last twelve months. So, this means that for every A$1 of its shareholder's investments, the company generates a profit of A$0.26.

Why Is ROE Important For Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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 IDP Education's Earnings Growth And 26% ROE

To begin with, IDP Education has a pretty high ROE which is interesting. Second, a comparison with the average ROE reported by the industry of 6.8% also doesn't go unnoticed by us. As a result, IDP Education's exceptional 23% net income growth seen over the past five years, doesn't come as a surprise.

As a next step, we compared IDP Education's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 12%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. 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 IDP Education is trading on a high P/E or a low P/E, relative to its industry.

Is IDP Education Making Efficient Use Of Its Profits?

The high three-year median payout ratio of 72% (implying that it keeps only 28% of profits) for IDP Education suggests that the company's growth wasn't really hampered despite it returning most of the earnings to its shareholders.

Besides, IDP Education has been paying dividends over a period of eight years. This shows that the company is committed to sharing profits with its shareholders. 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 71%. Accordingly, forecasts suggest that IDP Education's future ROE will be 29% which is again, similar to the current ROE.

Summary

Overall, we are quite pleased with IDP Education's performance. Especially the high ROE, Which has contributed to the impressive growth seen in earnings. Despite the company reinvesting only a small portion of its profits, it still has managed to grow its earnings so that is appreciable. That being so, a study of the latest analyst forecasts show that the company is expected to see a slowdown in its future earnings growth. 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.

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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.