Kabra Extrusiontechnik Limited (NSE:KABRAEXTRU) Stock Is Going Strong But Fundamentals Look Uncertain: What Lies Ahead ?

Kabra Extrusiontechnik (NSE:KABRAEXTRU) has had a great run on the share market with its stock up by a significant 37% over the last three months. But the company's key financial indicators appear to be differing across the board and that makes us question whether or not the company's current share price momentum can be maintained. In this article, we decided to focus on Kabra Extrusiontechnik's ROE.

Return on equity or ROE is an important factor to be considered by a shareholder because it tells them how effectively their capital is being reinvested. In simpler terms, it measures the profitability of a company in relation to shareholder's equity.

Check out our latest analysis for Kabra Extrusiontechnik

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 Kabra Extrusiontechnik is:

4.8% = ₹122m ÷ ₹2.5b (Based on the trailing twelve months to September 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?

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. 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.

Kabra Extrusiontechnik's Earnings Growth And 4.8% ROE

It is quite clear that Kabra Extrusiontechnik's ROE is rather low. Not just that, even compared to the industry average of 8.5%, the company's ROE is entirely unremarkable. Given the circumstances, the significant decline in net income by 17% seen by Kabra Extrusiontechnik over the last five years is not surprising. However, there could also be other factors causing the earnings to decline. For example, the business has allocated capital poorly, or that the company has a very high payout ratio.

That being said, we compared Kabra Extrusiontechnik'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 9.2% in the same period.

Earnings growth is an important metric to consider when valuing a stock. What investors need to determine next is if the expected earnings growth, or the lack of it, is already built into the share price. Doing so will help them establish if the stock's future looks promising or ominous. One good indicator of expected earnings growth is the P/E ratio which determines the price the market is willing to pay for a stock based on its earnings prospects. So, you may want to check if Kabra Extrusiontechnik is trading on a high P/E or a low P/E, relative to its industry.

Is Kabra Extrusiontechnik Using Its Retained Earnings Effectively?

Looking at its three-year median payout ratio of 32% (or a retention ratio of 68%) which is pretty normal, Kabra Extrusiontechnik'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 could be some other explanations in that regard. For instance, the company's business may be deteriorating.

In addition, Kabra Extrusiontechnik 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 Kabra Extrusiontechnik. While the company does have a high rate of reinvestment, the low ROE means that all that reinvestment is not reaping any benefit to its investors, and moreover, its having a negative impact on the earnings growth. 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. To know the 4 risks we have identified for Kabra Extrusiontechnik visit our risks dashboard for free.

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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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