Is Weakness In Mahindra EPC Irrigation Limited (NSE:MAHEPC) Stock A Sign That The Market Could be Wrong Given Its Strong Financial Prospects?

Mahindra EPC Irrigation (NSE:MAHEPC) has had a rough three months with its share price down 9.8%. However, a closer look at its sound financials might cause you to think again. Given that fundamentals usually drive long-term market outcomes, the company is worth looking at. In this article, we decided to focus on Mahindra EPC Irrigation'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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

See our latest analysis for Mahindra EPC Irrigation

How To Calculate Return On Equity?

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 Mahindra EPC Irrigation is:

14% = ₹240m ÷ ₹1.7b (Based on the trailing twelve months to June 2020).

The 'return' is the yearly profit. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.14 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 Mahindra EPC Irrigation's Earnings Growth And 14% ROE

When you first look at it, Mahindra EPC Irrigation's ROE doesn't look that attractive. However, the fact that the its ROE is quite higher to the industry average of 8.7% doesn't go unnoticed by us. Particularly, the substantial 29% net income growth seen by Mahindra EPC Irrigation over the past five years is impressive . Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. 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 Mahindra EPC Irrigation'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 9.4%.

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 Mahindra EPC Irrigation's's valuation, check out this gauge of its price-to-earnings ratio, as compared to its industry.

Is Mahindra EPC Irrigation Efficiently Re-investing Its Profits?

Mahindra EPC Irrigation 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. So it looks like Mahindra EPC Irrigation is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Along with seeing a growth in earnings, Mahindra EPC Irrigation only recently started paying dividends. Its quite possible that the company was looking to impress its shareholders.

Summary

On the whole, we feel that Mahindra EPC Irrigation's performance has been quite good. Particularly, we like that the company is reinvesting heavily into its business at a moderate rate of return. Unsurprisingly, this has led to an impressive earnings growth. 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. You can see the 2 risks we have identified for Mahindra EPC Irrigation by visiting our risks dashboard for free on our platform here.

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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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