Are ESAB India Limited's (NSE:ESABINDIA) Fundamentals Good Enough to Warrant Buying Given The Stock's Recent Weakness?

With its stock down 8.4% over the past month, it is easy to disregard ESAB India (NSE:ESABINDIA). But if you pay close attention, you might find that its key financial indicators look quite decent, which could mean that the stock could potentially rise in the long-term given how markets usually reward more resilient long-term fundamentals. Specifically, we decided to study ESAB India's ROE in this article.

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. In short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for ESAB India

How Is ROE Calculated?

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 ESAB India is:

18% = ₹619m ÷ ₹3.4b (Based on the trailing twelve months to June 2020).

The 'return' is the yearly profit. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.18.

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. 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 ESAB India's Earnings Growth And 18% ROE

To begin with, ESAB India seems to have a respectable ROE. On comparing with the average industry ROE of 8.5% the company's ROE looks pretty remarkable. Probably as a result of this, ESAB India was able to see an impressive net income growth of 27% over the last five years. We believe that there might also be other aspects that are positively influencing the company's earnings growth. For instance, the company has a low payout ratio or is being managed efficiently.

We then compared ESAB India's net income growth with the industry and we're pleased to see that the company's growth figure is higher when compared with the industry which has a 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). This then helps them determine if the stock is placed for a bright or bleak future. 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 ESAB India is trading on a high P/E or a low P/E, relative to its industry.

Is ESAB India Efficiently Re-investing Its Profits?

ESAB India's very high three-year median payout ratio of 151% suggests that the company is paying more to its shareholders than what it is earning. Despite this, the company's earnings grew significantly as we saw above. With that said, it could be worth keeping an eye on the high payout ratio as that's a huge risk.

Moreover, ESAB India 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 feel that ESAB India certainly does have some positive factors to consider. Namely, its high earnings growth, which was likely due to its high ROE. However, investors could have benefitted even more from the high ROE, had the company been reinvesting more of its earnings. As discussed earlier, the company is retaining hardly any of its profits. Up till now, we've only made a short study of the company's growth data. So it may be worth checking this free detailed graph of ESAB India's past earnings, as well as revenue and cash flows to get a deeper insight into the company's performance.

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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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