Mahanagar Gas Limited's (NSE:MGL) Fundamentals Look Pretty Strong: Could The Market Be Wrong About The Stock?

It is hard to get excited after looking at Mahanagar Gas' (NSE:MGL) recent performance, when its stock has declined 16% over the past three months. 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 Mahanagar Gas' 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.

View our latest analysis for Mahanagar Gas

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 Mahanagar Gas is:

23% = ₹6.7b ÷ ₹30b (Based on the trailing twelve months to June 2020).

The 'return' refers to a company's earnings over the last year. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.23 in profit.

What Is The Relationship Between ROE And Earnings Growth?

So far, we've learned 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. 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.

Mahanagar Gas' Earnings Growth And 23% ROE

At first glance, Mahanagar Gas seems to have a decent ROE. Even when compared to the industry average of 25% the company's ROE looks quite decent. This certainly adds some context to Mahanagar Gas' exceptional 21% net income growth seen over the past five years. However, there could also be other drivers behind this growth. Such as - high earnings retention or an efficient management in place.

We then compared Mahanagar Gas' net income growth with the industry and found that the company's growth figure is lower than the average industry growth rate of 26% in the same period, which is a bit concerning.

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. Has the market priced in the future outlook for MGL? You can find out in our latest intrinsic value infographic research report

Is Mahanagar Gas Efficiently Re-investing Its Profits?

Mahanagar Gas' three-year median payout ratio is a pretty moderate 27%, meaning the company retains 73% of its income. So it seems that Mahanagar Gas is reinvesting efficiently in a way that it sees impressive growth in its earnings (discussed above) and pays a dividend that's well covered.

Besides, Mahanagar Gas has been paying dividends over a period of four years. This shows that the company is committed to sharing profits with its shareholders.

Conclusion

On the whole, we feel that Mahanagar Gas' performance has been quite good. In particular, it's great to see that the company is investing heavily into its business and along with a high rate of return, that has resulted in a respectable growth in its earnings. 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. Remember, the price of a stock is also dependent on the perceived risk. Therefore investors must keep themselves informed about the risks involved before investing in any company. You can see the 2 risks we have identified for Mahanagar Gas 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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