Most readers would already be aware that Birla’s (NSE:BIRLACORPN) stock increased significantly by 13% over the past month. As most would know, fundamentals are what usually guide market price movements over the long-term, so we decided to look at the company’s key financial indicators today to determine if they have any role to play in the recent price movement. Specifically, we decided to study Birla’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.
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 Birla is:
9.0% = ₹4.3b ÷ ₹48b (Based on the trailing twelve months to June 2020).
The ‘return’ is the profit over the last twelve months. One way to conceptualize this is that for each ₹1 of shareholders’ capital it has, the company made ₹0.09 in profit.
What Has ROE Got To Do With Earnings Growth?
Thus far, we have learned that ROE measures how efficiently a company is generating its profits. 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. 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 Birla’s Earnings Growth And 9.0% ROE
It is quite clear that Birla’s ROE is rather low. An industry comparison shows that the company’s ROE is not much different from the industry average of 9.0% either. However, the exceptional 30% net income growth seen by Birla over the past five years is pretty remarkable. We reckon that there could also be other factors at play thats influencing the company’s growth. For instance, the company has a low payout ratio or is being managed efficiently.
Next, on comparing with the industry net income growth, we found that Birla’s growth is quite high when compared to the industry average growth of 12% in the same period, which is great to see.
The basis for attaching value to a company is, to a great extent, tied to its earnings growth. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock’s future looks promising or ominous. If you’re wondering about Birla’s’s valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.
Is Birla Efficiently Re-investing Its Profits?
Birla’s three-year median payout ratio to shareholders is 23%, which is quite low. This implies that the company is retaining 77% of its profits. So it seems like the management is reinvesting profits heavily to grow its business and this reflects in its earnings growth number.
Additionally, Birla 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.
On the whole, we do feel that Birla has some positive attributes. 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. We also studied the latest analyst forecasts and found that the company’s earnings growth is expected be similar to its current growth rate. To know more about the latest analysts predictions for the company, check out this visualization of analyst forecasts for the company.
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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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