Sterling Tools Limited's (NSE:STERTOOLS) Stock is Soaring But Financials Seem Inconsistent: Will The Uptrend Continue?

Sterling Tools (NSE:STERTOOLS) has had a great run on the share market with its stock up by a significant 15% over the last three months. However, we decided to pay attention to the company's fundamentals which don't appear to give a clear sign about the company's financial health. Specifically, we decided to study Sterling Tools' ROE in this article.

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 short, ROE shows the profit each dollar generates with respect to its shareholder investments.

View our latest analysis for Sterling Tools

How Is ROE Calculated?

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 Sterling Tools is:

4.1% = ₹127m ÷ ₹3.1b (Based on the trailing twelve months to June 2020).

The 'return' is the amount earned after tax over the last twelve months. So, this means that for every ₹1 of its shareholder's investments, the company generates a profit of ₹0.04.

What Has ROE Got To Do With Earnings Growth?

We have already established that ROE serves as an efficient profit-generating gauge for a company's future earnings. 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 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 Sterling Tools' Earnings Growth And 4.1% ROE

As you can see, Sterling Tools' ROE looks pretty weak. Even when compared to the industry average of 5.7%, the ROE figure is pretty disappointing. Therefore, Sterling Tools' flat earnings over the past five years can possibly be explained by the low ROE amongst other factors.

Next, on comparing with the industry net income growth, we found that Sterling Tools' reported growth was lower than the industry growth of 5.2% in the same period, which is not something we like to see.

The basis for attaching value to a company is, to a great extent, tied to its earnings growth. It’s important for an investor to know whether the market has priced in the company's expected earnings growth (or decline). By doing so, they will have an idea if the stock is headed into clear blue waters or if swampy waters await. Is Sterling Tools fairly valued compared to other companies? These 3 valuation measures might help you decide.

Is Sterling Tools Making Efficient Use Of Its Profits?

Sterling Tools' low three-year median payout ratio of 16%, (meaning the company retains84% of profits) should mean that the company is retaining most of its earnings and consequently, should see higher growth than it has reported.

In addition, Sterling Tools 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

On the whole, we feel that the performance shown by Sterling Tools can be open to many interpretations. While the company does have a high rate of profit retention, its low rate of return is probably hampering its earnings growth. Until now, we have only just grazed the surface of the company's past performance by looking at the company's fundamentals. To gain further insights into Sterling Tools' past profit growth, check out this visualization of past earnings, revenue and cash flows.

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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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