Rane Brake Lining Limited's (NSE:RBL) Stock Has Seen Strong Momentum: Does That Call For Deeper Study Of Its Financial Prospects?

Rane Brake Lining's (NSE:RBL) stock is up by a considerable 23% over the past three months. We wonder if and what role the company's financials play in that price change as a company's long-term fundamentals usually dictate market outcomes. In this article, we decided to focus on Rane Brake Lining'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.

View our latest analysis for Rane Brake Lining

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 Rane Brake Lining is:

11% = ₹242m ÷ ₹2.2b (Based on the trailing twelve months to September 2020).

The 'return' is the yearly profit. One way to conceptualize this is that for each ₹1 of shareholders' capital it has, the company made ₹0.11 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. 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 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.

Rane Brake Lining's Earnings Growth And 11% ROE

When you first look at it, Rane Brake Lining's ROE doesn't look that attractive. However, the fact that the its ROE is quite higher to the industry average of 5.4% doesn't go unnoticed by us. Yet, Rane Brake Lining has posted measly growth of 2.3% over the past five years. Bear in mind, the company does have a low ROE. It is just that the industry ROE is lower. Hence, this goes some way in explaining the low earnings growth.

As a next step, we compared Rane Brake Lining's net income growth with the industry and were disappointed to see that the company's growth is lower than the industry average growth of 4.8% in the same period.

Earnings growth is an important metric to consider when valuing a stock. The investor should try to establish if the expected growth or decline in earnings, whichever the case may be, is priced in. Doing so will help them establish if the stock's future looks promising or ominous. Is Rane Brake Lining fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Rane Brake Lining Using Its Retained Earnings Effectively?

While Rane Brake Lining has a decent three-year median payout ratio of 36% (or a retention ratio of 64%), it has seen very little growth in earnings. So there might be other factors at play here which could potentially be hampering growth. For example, the business has faced some headwinds.

Additionally, Rane Brake Lining has paid dividends over a period of at least ten years, which means that the company's management is determined to pay dividends even if it means little to no earnings growth.

Conclusion

On the whole, we do feel that Rane Brake Lining has some positive attributes. Although, we are disappointed to see a lack of growth in earnings even in spite of a moderate ROE and and a high reinvestment rate. We believe that there might be some outside factors that could be having a negative impact on the business. While we won't completely dismiss the company, what we would do, is try to ascertain how risky the business is to make a more informed decision around the company. To know the 3 risks we have identified for Rane Brake Lining 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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