Akzo Nobel India Limited's (NSE:AKZOINDIA) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

Akzo Nobel India (NSE:AKZOINDIA) has had a rough three months with its share price down 12%. However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to Akzo Nobel India's ROE today.

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. Simply put, it is used to assess the profitability of a company in relation to its equity capital.

See our latest analysis for Akzo Nobel India

How Do You Calculate Return On Equity?

The formula for return on equity is:

Return on Equity = Net Profit (from continuing operations) ÷ Shareholders' Equity

So, based on the above formula, the ROE for Akzo Nobel India is:

19% = ₹2.4b ÷ ₹12b (Based on the trailing twelve months to March 2020).

The 'return' refers to a company's earnings over the last year. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.19 in profit.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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. 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.

Akzo Nobel India's Earnings Growth And 19% ROE

To start with, Akzo Nobel India's ROE looks acceptable. Especially when compared to the industry average of 12% the company's ROE looks pretty impressive. Despite this, Akzo Nobel India's five year net income growth was quite low averaging at only 4.5%. That's a bit unexpected from a company which has such a high rate of return. We reckon that a low growth, when returns are quite high could be the result of certain circumstances like low earnings retention or poor allocation of capital.

As a next step, we compared Akzo Nobel India's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 19% in the same period.

Earnings growth is a huge factor in stock valuation. 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. What is AKZOINDIA worth today? The intrinsic value infographic in our free research report helps visualize whether AKZOINDIA is currently mispriced by the market.

Is Akzo Nobel India Using Its Retained Earnings Effectively?

While Akzo Nobel India has a decent three-year median payout ratio of 47% (or a retention ratio of 53%), it has seen very little growth in earnings. So there could be some other explanation in that regard. For instance, the company's business may be deteriorating.

Additionally, Akzo Nobel India has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Conclusion

Overall, we feel that Akzo Nobel India certainly does have some positive factors to consider. However, given the high ROE and high profit retention, we would expect the company to be delivering strong earnings growth, but that isn't the case here. This suggests that there might be some external threat to the business, that's hampering its 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. You can see the 1 risk we have identified for Akzo Nobel India by visiting our risks dashboard for free on our platform here.

If you decide to trade Akzo Nobel India, use the lowest-cost* platform that is rated #1 Overall by Barron’s, Interactive Brokers. Trade stocks, options, futures, forex, bonds and funds on 135 markets, all from a single integrated account.Promoted

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.
^*Interactive Brokers Rated Lowest Cost Broker by StockBrokers.com Annual Online Review 2020

Have feedback on this article? Concerned about the content? Get in touch with us directly. Alternatively, email editorial-team@simplywallst.com.