Is Novartis India Limited's (NSE:NOVARTIND) Recent Performance Market's Way Of Responding to Its Mixed Financials?

Looking at Novartis India's (NSE:NOVARTIND) mostly flat share price movement over the past three months, it is easy to think that there’s nothing interesting about the stock. Looking at its differing financials, we wonder if the market is focusing more on the company's negatives than on the positives resulting in the stock's drab performance. Specifically, we decided to study Novartis India'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 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 Novartis India

How Is ROE Calculated?

ROE 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 Novartis India is:

1.9% = ₹137m ÷ ₹7.2b (Based on the trailing twelve months to June 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 ₹0.02.

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. 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 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 Novartis India's Earnings Growth And 1.9% ROE

It is hard to argue that Novartis India's ROE is much good in and of itself. Even when compared to the industry average of 13%, the ROE figure is pretty disappointing. Given the circumstances, the significant decline in net income by 27% seen by Novartis India over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. For instance, the company has a very high payout ratio, or is faced with competitive pressures.

That being said, we compared Novartis India's performance with the industry and were concerned when we found that while the company has shrunk its earnings, the industry has grown its earnings at a rate of 14% in the same period.

Earnings growth is an important metric to consider when valuing a stock. 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. If you're wondering about Novartis India's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Novartis India Using Its Retained Earnings Effectively?

Looking at its three-year median payout ratio of 48% (or a retention ratio of 52%) which is pretty normal, Novartis India's declining earnings is rather baffling as one would expect to see a fair bit of growth when a company is retaining a good portion of its profits. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

In addition, Novartis India has been paying dividends over a period of at least ten years suggesting that keeping up dividend payments is way more important to the management even if it comes at the cost of business growth.

Conclusion

Overall, we have mixed feelings about Novartis India. Even though it appears to be retaining most of its profits, given the low ROE, investors may not be benefitting from all that reinvestment after all. The low earnings growth suggests our theory correct. Wrapping up, we would proceed with caution with this company and one way of doing that would be to look at the risk profile of the business. Our risks dashboard would have the 3 risks we have identified for Novartis India.

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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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