Are Robust Financials Driving The Recent Rally In Welspun Investments and Commercials Limited's (NSE:WELINV) Stock?

Most readers would already be aware that Welspun Investments and Commercials' (NSE:WELINV) stock increased significantly by 69% over the past three months. Given the company's impressive performance, we decided to study its financial indicators more closely as a company's financial health over the long-term usually dictates market outcomes. Specifically, we decided to study Welspun Investments and Commercials' 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.

See our latest analysis for Welspun Investments and Commercials

How Is ROE Calculated?

The formula for ROE is:

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

So, based on the above formula, the ROE for Welspun Investments and Commercials is:

12% = ₹73m ÷ ₹607m (Based on the trailing twelve months to March 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 ₹0.12.

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. 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 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 Welspun Investments and Commercials' Earnings Growth And 12% ROE

When you first look at it, Welspun Investments and Commercials' ROE doesn't look that attractive. However, the fact that the company's ROE is higher than the average industry ROE of 3.4%, is definitely interesting. Particularly, the substantial 64% net income growth seen by Welspun Investments and Commercials over the past five years is impressive . Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. So, there might well be other reasons for the earnings to grow. E.g the company has a low payout ratio or could belong to a high growth industry.

Next, on comparing with the industry net income growth, we found that Welspun Investments and Commercials' growth is quite high when compared to the industry average growth of 24% in the same period, which is great to see.

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. 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 Welspun Investments and Commercials is trading on a high P/E or a low P/E, relative to its industry.

Is Welspun Investments and Commercials Using Its Retained Earnings Effectively?

Welspun Investments and Commercials doesn't pay any dividend currently which essentially means that it has been reinvesting all of its profits into the business. This definitely contributes to the high earnings growth number that we discussed above.

Summary

In total, we are pretty happy with Welspun Investments and Commercials' performance. Specifically, we like that it has been reinvesting a high portion of its profits at a moderate rate of return, resulting in earnings expansion. If the company continues to grow its earnings the way it has, that could have a positive impact on its share price given how earnings per share influence long-term share prices. Let's not forget, business risk is also one of the factors that affects the price of the stock. So this is also an important area that investors need to pay attention to before making a decision on any business. You can see the 3 risks we have identified for Welspun Investments and Commercials by visiting our risks dashboard for free on our platform here.

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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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