Declining Stock and Solid Fundamentals: Is The Market Wrong About Kaveri Seed Company Limited (NSE:KSCL)?

With its stock down 20% over the past three months, it is easy to disregard Kaveri Seed (NSE:KSCL). But if you pay close attention, you might gather that its strong financials could mean that the stock could potentially see an increase in value in the long-term, given how markets usually reward companies with good financial health. In this article, we decided to focus on Kaveri Seed's ROE.

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 simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Kaveri Seed

How Is ROE Calculated?

Return on equity can be calculated by using the formula:

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

So, based on the above formula, the ROE for Kaveri Seed is:

34% = ₹3.3b ÷ ₹9.6b (Based on the trailing twelve months to June 2020).

The 'return' is the profit over the last twelve months. Another way to think of that is that for every ₹1 worth of equity, the company was able to earn ₹0.34 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. 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.

Kaveri Seed's Earnings Growth And 34% ROE

Firstly, we acknowledge that Kaveri Seed has a significantly high ROE. Additionally, the company's ROE is higher compared to the industry average of 10.0% which is quite remarkable. This probably laid the groundwork for Kaveri Seed's moderate 6.3% net income growth seen over the past five years.

We then compared Kaveri Seed's net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 17% in the same period, which is a bit concerning.

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. What is KSCL worth today? The intrinsic value infographic in our free research report helps visualize whether KSCL is currently mispriced by the market.

Is Kaveri Seed Using Its Retained Earnings Effectively?

In Kaveri Seed's case, its respectable earnings growth can probably be explained by its low three-year median payout ratio of 8.9% (or a retention ratio of 91%), which suggests that the company is investing most of its profits to grow its business.

Besides, Kaveri Seed has been paying dividends for at least ten years or more. This shows that the company is committed to sharing profits with its shareholders. Our latest analyst data shows that the future payout ratio of the company is expected to drop to 6.3% over the next three years. Regardless, the future ROE for Kaveri Seed is predicted to decline to 27% despite the anticipated decrease in the payout ratio. We reckon that there could probably be other factors that could be driving the forseen decline in the company's ROE.

Summary

In total, we are pretty happy with Kaveri Seed's performance. Specifically, we like that the company is reinvesting a huge chunk of its profits at a high rate of return. This of course has caused the company to see a good amount of growth in its earnings. With that said, the latest industry analyst forecasts reveal that the company's earnings are expected to accelerate. Are these analysts expectations based on the broad expectations for the industry, or on the company's fundamentals? Click here to be taken to our analyst's forecasts page 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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