Ador Welding Limited's (NSE:ADORWELD) Stock Has Shown Weakness Lately But Financial Prospects Look Decent: Is The Market Wrong?

Ador Welding (NSE:ADORWELD) has had a rough three months with its share price down 9.4%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Particularly, we will be paying attention to Ador Welding's ROE today.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Ador Welding

How Do You 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 Ador Welding is:

9.2% = ₹245m ÷ ₹2.7b (Based on the trailing twelve months to June 2020).

The 'return' is the yearly profit. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.09 in profit.

What Is The Relationship Between ROE And Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. We now need to evaluate how much profit the company reinvests or "retains" for future growth which then gives us an idea about the growth potential of the company. 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 Ador Welding's Earnings Growth And 9.2% ROE

It is quite clear that Ador Welding's ROE is rather low. An industry comparison shows that the company's ROE is not much different from the industry average of 8.5% either. However, the modest 8.6% net income growth seen by Ador Welding over the past five years is a positive sign. Given the low ROE, it is likely that there could be some other aspects that are driving this growth as well. For example, it is possible that the company's management has made some good strategic decisions, or that the company has a low payout ratio.

Next, on comparing Ador Welding's net income growth with the industry, we found that the company's reported growth is similar to the industry average growth rate of 11% 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). Doing so will help them establish if the stock's future looks promising or ominous. If you're wondering about Ador Welding's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Ador Welding Making Efficient Use Of Its Profits?

With a three-year median payout ratio of 36% (implying that the company retains 64% of its profits), it seems that Ador Welding is reinvesting efficiently in a way that it sees respectable amount growth in its earnings and pays a dividend that's well covered.

Additionally, Ador Welding has paid dividends over a period of at least ten years which means that the company is pretty serious about sharing its profits with shareholders.

Summary

Overall, we feel that Ador Welding certainly does have some positive factors to consider. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. 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 Ador Welding visit our risks dashboard for free.

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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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