Mahindra EPC Irrigation Limited's (NSE:MAHEPC) Stock's On An Uptrend: Are Strong Financials Guiding The Market?

Mahindra EPC Irrigation's's (NSE:MAHEPC) stock is up by a considerable 64% over the past three months. Since the market usually pay for a company’s long-term fundamentals, we decided to study the company’s key performance indicators to see if they could be influencing the market. In this article, we decided to focus on Mahindra EPC Irrigation's ROE.

Return on equity or ROE is a key measure used to assess how efficiently a company's management is utilizing the company's capital. In other words, it is a profitability ratio which measures the rate of return on the capital provided by the company's shareholders.

See our latest analysis for Mahindra EPC Irrigation

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 Mahindra EPC Irrigation is:

14% = ₹230m ÷ ₹1.7b (Based on the trailing twelve months to March 2020).

The 'return' refers to a company's earnings over the last year. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.14 in profit.

What Is The Relationship Between ROE And Earnings Growth?

Thus far, we have learnt 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 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 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 11% doesn't go unnoticed by us. Especially when you consider Mahindra EPC Irrigation's exceptional 28% net income growth over the past five years. Bear in mind, the company does have a moderately low ROE. It is just that the industry ROE is lower. Hence, there might be some other aspects that are causing earnings to grow. For example, it is possible that the broader industry is going through a high growth phase, or that the company has a low payout ratio.

Next, on comparing with the industry net income growth, we found that Mahindra EPC Irrigation's growth is quite high when compared to the industry average growth of 14% in the same period, which is great 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. By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. 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 Mahindra EPC Irrigation is trading on a high P/E or a low P/E, relative to its industry.

Is Mahindra EPC Irrigation Using Its Retained Earnings Effectively?

Mahindra EPC Irrigation's ' three-year median payout ratio is on the lower side at 18% implying that it is retaining a higher percentage (82%) of its profits. So it looks like Mahindra EPC Irrigation is reinvesting profits heavily to grow its business, which shows in its earnings growth.

While Mahindra EPC Irrigation has seen growth in its earnings, it only recently started to pay a dividend. It is most likely that the company decided to impress new and existing shareholders with a dividend.

Conclusion

In total, we are pretty happy with Mahindra EPC Irrigation's performance. 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 3 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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