International Paper (NYSE:IP) has had a great run on the share market with its stock up by a significant 21% 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 International Paper's ROE in this article.

Return on Equity or ROE is a test of how effectively a company is growing its value and managing investors' money. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

How To Calculate Return On Equity?

ROE 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 International Paper is:

4.9% = US$420m ÷ US$8.6b (Based on the trailing twelve months to September 2024).

The 'return' is the profit over the last twelve months. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.05 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. 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. 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 International Paper's Earnings Growth And 4.9% ROE

On the face of it, International Paper's ROE is not much to talk about. A quick further study shows that the company's ROE doesn't compare favorably to the industry average of 13% either. Hence, the flat earnings seen by International Paper over the past five years could probably be the result of it having a lower ROE.

Next, on comparing with the industry net income growth, we found that the industry grew its earnings by 7.1% over the last few years.

Earnings growth is a huge factor in stock valuation. It's important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). 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 IP? You can find out in our latest intrinsic value infographic research report.

Is International Paper Efficiently Re-investing Its Profits?

With a high three-year median payout ratio of 88% (implying that the company keeps only 12% of its income) of its business to reinvest into its business), most of International Paper's profits are being paid to shareholders, which explains the absence of growth in earnings.

Moreover, International Paper has been paying dividends for at least ten years or more suggesting that management must have perceived that the shareholders prefer dividends over earnings growth. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 52% over the next three years. The fact that the company's ROE is expected to rise to 14% over the same period is explained by the drop in the payout ratio.

Conclusion

On the whole, International Paper's performance is quite a big let-down. As a result of its low ROE and lack of much reinvestment into the business, the company has seen a disappointing earnings growth rate. That being so, the latest industry analyst forecasts show that the analysts are expecting to see a huge improvement in the company's earnings growth rate. 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.