Should Weakness in Kilitch Drugs (India) Limited's (NSE:KILITCH) Stock Be Seen As A Sign That Market Will Correct The Share Price Given Decent Financials?

Kilitch Drugs (India) (NSE:KILITCH) has had a rough month with its share price down 19%. However, stock prices are usually driven by a company’s financials over the long term, which in this case look pretty respectable. Specifically, we decided to study Kilitch Drugs (India)'s ROE in this article.

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 Kilitch Drugs (India)

How To Calculate Return On Equity?

Return on equity 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 Kilitch Drugs (India) is:

0.7% = ₹8.4m ÷ ₹1.2b (Based on the trailing twelve months to March 2020).

The 'return' is the amount earned after tax over the last twelve months. That means that for every ₹1 worth of shareholders' equity, the company generated ₹0.01 in profit.

What Has ROE Got To Do With Earnings Growth?

So far, we've learned that ROE is a measure of a company's profitability. Based on how much of its profits the company chooses to reinvest or "retain", we are then able to evaluate a company's future ability to generate profits. 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.

A Side By Side comparison of Kilitch Drugs (India)'s Earnings Growth And 0.7% ROE

It is quite clear that Kilitch Drugs (India)'s ROE is rather low. Even when compared to the industry average of 12%, the ROE figure is pretty disappointing. In spite of this, Kilitch Drugs (India) was able to grow its net income considerably, at a rate of 38% in the last five years. Therefore, there could be other reasons behind this growth. For instance, the company has a low payout ratio or is being managed efficiently.

As a next step, we compared Kilitch Drugs (India)'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 16%.

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. Is Kilitch Drugs (India) fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Kilitch Drugs (India) Using Its Retained Earnings Effectively?

Kilitch Drugs (India)'s three-year median payout ratio to shareholders is 16%, which is quite low. This implies that the company is retaining 84% of its profits. So it looks like Kilitch Drugs (India) is reinvesting profits heavily to grow its business, which shows in its earnings growth.

Moreover, Kilitch Drugs (India) is determined to keep sharing its profits with shareholders which we infer from its long history of paying a dividend for at least ten years.

Summary

Overall, we feel that Kilitch Drugs (India) certainly does have some positive factors to consider. Despite its low rate of return, the fact that the company reinvests a very high portion of its profits into its business, no doubt contributed to its high earnings growth. 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 Kilitch Drugs (India) 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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