Innospec (NASDAQ:IOSP) has had a rough three months with its share price down 7.7%. But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. Specifically, we decided to study Innospec's ROE in this article.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

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 Innospec is:

13% = US$150m ÷ US$1.2b (Based on the trailing twelve months to June 2024).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each $1 of shareholders' capital it has, the company made $0.13 in profit.

What Has ROE Got To Do With 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. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of Innospec's Earnings Growth And 13% ROE

To start with, Innospec's ROE looks acceptable. Especially when compared to the industry average of 9.9% the company's ROE looks pretty impressive. This probably laid the ground for Innospec's moderate 15% net income growth seen over the past five years.

As a next step, we compared Innospec's net income growth with the industry and found that the company has a similar growth figure when compared with the industry average growth rate of 13% in the same period.

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. Is Innospec fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Innospec Efficiently Re-investing Its Profits?

With a three-year median payout ratio of 26% (implying that the company retains 74% of its profits), it seems that Innospec is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Moreover, Innospec 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.

Summary

Overall, we are quite pleased with Innospec's performance. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a sizeable growth in its earnings. 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 latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.

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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.