EIH Limited (NSE:EIHOTEL) Stock's Been Sliding But Fundamentals Look Decent: Will The Market Correct The Share Price In The Future?

With its stock down 15% over the past month, it is easy to disregard EIH (NSE:EIHOTEL). However, the company's fundamentals look pretty decent, and long-term financials are usually aligned with future market price movements. Particularly, we will be paying attention to EIH's ROE today.

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 other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

View our latest analysis for EIH

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 EIH is:

5.1% = ₹1.7b ÷ ₹32b (Based on the trailing twelve months to March 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 ₹0.05 in profit.

Why Is ROE Important For Earnings Growth?

So far, we've learnt that ROE is a measure of a company's profitability. Depending on how much of these profits the company reinvests or "retains", and how effectively it does so, we are then able to assess a company’s earnings growth potential. Assuming all else is equal, companies that have both a higher return on equity and higher profit retention are usually the ones that have a higher growth rate when compared to companies that don't have the same features.

A Side By Side comparison of EIH's Earnings Growth And 5.1% ROE

It is quite clear that EIH's ROE is rather low. Even when compared to the industry average of 7.6%, the ROE figure is pretty disappointing. However, the moderate 8.0% net income growth seen by EIH over the past five years is definitely a positive. We reckon that there could be other factors at play here. 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 EIH's reported growth was lower than the industry growth of 15% in the same period, which is not something we like 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. This then helps them determine if the stock is placed for a bright or bleak future. If you're wondering about EIH's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is EIH Using Its Retained Earnings Effectively?

EIH has a three-year median payout ratio of 39%, which implies that it retains the remaining 61% of its profits. This suggests that its dividend is well covered, and given the decent growth seen by the company, it looks like management is reinvesting its earnings efficiently.

Summary

On the whole, we do feel that EIH has some positive attributes. That is, a decent growth in earnings backed by a high rate of reinvestment. However, we do feel that that earnings growth could have been higher if the business were to improve on the low ROE rate. Especially given how the company is reinvesting a huge chunk of its profits.

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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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