Are Strong Financial Prospects The Force That Is Driving The Momentum In DCM Shriram Limited's NSE:DCMSHRIRAM) Stock?

Most readers would already be aware that DCM Shriram's (NSE:DCMSHRIRAM) stock increased significantly by 17% over the past three months. Given that the market rewards strong financials in the long-term, we wonder if that is the case in this instance. Specifically, we decided to study DCM Shriram'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.

Check out our latest analysis for DCM Shriram

How Do You Calculate Return On Equity?

The formula for ROE is:

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

So, based on the above formula, the ROE for DCM Shriram is:

14% = ₹5.7b ÷ ₹41b (Based on the trailing twelve months to June 2020).

The 'return' is the profit over the last twelve months. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.14 in profit.

Why Is ROE Important For 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. Generally speaking, other things being equal, firms with a high return on equity and profit retention, have a higher growth rate than firms that don’t share these attributes.

A Side By Side comparison of DCM Shriram's Earnings Growth And 14% ROE

On the face of it, DCM Shriram's ROE is not much to talk about. Although a closer study shows that the company's ROE is higher than the industry average of 11% which we definitely can't overlook. Even more so after seeing DCM Shriram's exceptional 23% net income growth over the past five years. That being said, the company does have a slightly low ROE to begin with, just that it is higher than the industry average. So, there might well be other reasons for the earnings to grow. Such as- high earnings retention or the company belonging to a high growth industry.

As a next step, we compared DCM Shriram's net income growth with the industry, and pleasingly, we found that the growth seen by the company is higher than the average industry growth of 17%.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. 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 DCM Shriram's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is DCM Shriram Making Efficient Use Of Its Profits?

DCM Shriram has a really low three-year median payout ratio of 18%, meaning that it has the remaining 82% left over to reinvest into its business. This suggests that the management is reinvesting most of the profits to grow the business as evidenced by the growth seen by the company.

Besides, DCM Shriram has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders.

Summary

In total, we are pretty happy with DCM Shriram's 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. To know the 3 risks we have identified for DCM Shriram 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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